Corks pop at REA Group

A heady combination of diversification and price rises mean REA Group is shrugging off a property market slowdown.

Think you need to buy property to get rich from real estate? Well, you don’t – you’ve just needed to own shares in online property classifieds company REA Group. This month the stock hit yet another all-time high; shareholders might be bored if they weren’t so busy cracking open the champagne.

There are a couple of reasons why the stock has motored up 12% since REA Group: Interim result 2016. The first is that many growth stocks are surging because long-term interest rates are plummeting. Plugging in lower interest rates tends to boost the valuations that drop out of broking analysts’ models (and that’s just one of their dirty little secrets).

The second is that, despite the doomsayers, segments of the property market remain buoyant. It might be a surprise to residents of Perth and western Sydney, but demand is high in many high-priced and inner urban areas in south-eastern Australia. Well it’s so hard to get a good decaf soy latte these days.

Key Points

  • National diversification helping REA

  • Earnings exceeding expectations

  • But business is now more cyclical

Whether it lists a property in Darlinghurst or Dalkeith, REA Group benefits from nationwide diversification. While listing volumes are currently down in Sydney, for example – a fact that’s contributing to the woes of recently listed real estate agency McGrath – they’re mostly up elsewhere. High prices also benefit REA Group these days because of its ‘market-based’ pricing policy; premium properties are often slugged with higher advertising rates.

In short, a nationwide property downturn would hit REA Group. So far, though, it’s not happening. Weak markets in some areas are being offset by strong ones elsewhere – and the changes to REA Group’s business model we’ve mentioned in past reviews mean earnings are continuing to grow.

Last month REA Group reported revenues and EBITDA up 20% and 25% respectively for the nine months to 31 March. You might have noticed the company is splurging on marketing at the moment but it can afford to. The company’s aim is to extend its lead over Fairfax’s Media’s Domain (which is less diversified and more exposed to the Sydney market).

Caring about sharing

Following on from the acquisition of 87% of iProperty Group in February, REA Group bought share accommodation website for $25m last month. It seems like a big price to pay for a free website but maybe the company considers it an add-on service for homeowners and property investors. Or perhaps management is getting sucked in by the whole ‘sharing economy’ thing – think Uber, Airbnb and WeWork.

While REA Group remains an outstanding business, it has become more cyclical over time. A more broadly-based housing downturn remains a risk – and one that prevents us from paying more than 30 times forecast 2016 earnings.

In past reviews we’ve been reluctant to commit to a price guide for REA Group. The reason is that stellar earnings growth can very quickly make a conservatively-couched price guide look out of date. But REA Group has exceeded all expectations thus far and letting go of the stock easily might be a mistake.

Nevertheless, we suggest you take profits as the stock rises. We’re re-introducing a price guide with our previously flagged Buy price of $40 but with a Sell price now above $75. That gives us – and you – a bit of wiggle room, and if the company continues to exceed expectations then we’ll lift the Sell price again.

For now REA Group looks somewhat expensive but you should deal with that via your portfolio weighting. It’s too good a business to sell completely, although taking something off the table is recommended. HOLD.

Disclosure: The author owns shares in Fairfax Media.

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