The property company that will still do well if the market falls
Key statistics: ASX: REA
Closing share price 22.08.17: $68.30 52-week high: $71.590 52-week low: $45.500 Most recent dividend: 51c Annual dividend yield: 1.33% Franking: 100%
In a softening property market you would expect that any company exposed to property will suffer.
But we don't think this is true for REA Group.
REA reported an underlying profit for full-year 2017 of $228.3 million, which was up about 12%. Most of the growth came in the more expensive "premium" depth ads.
REA has been able to demonstrate quality and competitive advantage, and at the right price. It certainly ticks the necessary investment criteria.
Despite an excess supply of websites offering to list a vendor's home or investment property - many for free - REA has been raising prices either directly or by creating and offering superior products and services for several years.
The result has been a strong growth in revenues even though listing volumes have been declining nationwide for some years.
Of the more than $7 billion spent on marketing residential real estate in Australia, an undeserving 83% goes to real estate agents. Less than 10% of the total spend goes to REA.
Since its 2011 listing, volumes have declined 21% nationwide. Consider that in 2011 REA reported revenue of $238 million and in 2016 it exceeded $629 million.
REA's revenue is a function of the number of ads listed multiplied by the time they are listed. Typically, each ad has a life of 30 to 45 days. In a booming market, properties don't remain listed for long, if they are listed at all.
In a mature market, however, auction clearance rates fall. There is an inverse relationship between time on market and auction clearance rates. As auction clearance rates decline, time on market increases.
If time on market increases, there must be more properties advertised at any one point in time. REA will therefore benefit.
If it becomes harder for vendors to sell, it follows that selling becomes more competitive, suggesting a higher propensity to "feature" one's property by paying up for a "highlight" ad, which equals more revenue for REA not only from more ads overall but also a higher proportion of premier ads.
And thanks to properties taking longer to sell, there will be more choice, causing buyer wariness, and listings will remain on the site longer.
So growth will come from more listings, longer listings, a higher proportion of depth/premium ads and price rises. That sounds like growth on growth, on growth, on growth.
Citi now has a target price of $80 on REA, similar to our own upper valuation.