Domain: Interim result 2019

The thing about great businesses is that they occasionally whack you with just how good they are. Friday's Domain Holdings result was the latest example.

The result was particularly startling because property listings have plummeted in Domain's core markets of inner suburban Sydney and Melbourne. Listings were down 10% in Sydney during the first half of 2019, and more like 20% in the inner suburbs where Domain is strongest.

What's more, there's little evidence listings will improve in the short term. Melbourne listings have worsened into the new year (although January is a slow month). Various elections, as well as the lateness of Easter - which means less pressure on vendors to organise themselves - will add to uncertainty in the second half.

You might assume the listings declines would imply a fall in Domain's residential revenue. But no - in fact the company grew residential revenue by 9% to $94m. The reason is that Domain has been having across-the-board success selling premium - or 'depth' - ads. As new managing director Jason Pellegrino said: 'Improvements in depth penetration were achieved in all key markets with particular progress in Victoria and our emerging markets of Queensland and South Australia'.

So there you have it: confirmation of a key plank in the investment case. Domain is selling more premium ads in areas outside its core inner Sydney and Melbourne markets. It's additionally reassuring that Victoria - a problem child in the 2018 result - showed some improvement.

Bungee jump

Just like that, Domain's share price rose 21% on Friday.

Nor was increasing depth penetration the only positive in the result. Print revenues plunged 24% to $33m but excellent cost control saw earnings before interest, tax, depreciation and amortisation (EBITDA) fall just 10% to $10m.

In fact, cost control was a feature of the result more generally. Costs grew just 4% after management forecast 'mid-to-high single digit' growth in October. Domain needs to keep investing in its brand so marketing costs were spared the cuts, which is reassuring.

Domain doesn't split out the revenue it receives from property developers, as it's contained in a single 'Media, developers and commercial' segment. Here revenue fell 10% to $26m, reflecting weakness in apartment project advertising in Sydney, offset by 20% growth in commercial revenue. Again, it could have been worse.

Altogether, Domain's half-yearly revenue was flat at $184m, while EBITDA fell 7% to $53m. The result wasn't quite as good as it looked, however. An additional week in the half boosted EBITDA by almost $2m and the February 2018 acquisition of Review Property also lifted earnings. Excluding these, we estimate that EBITDA fell more like 15%.

We said at the time of last year's half-yearly result that Domain's interim dividend of 4 cents was 'a little on the high side'. So it wasn't overly surprising to see it cut to 2 cents this time, apparently because the company also impaired goodwill by $179m in the half. Domain is a high cash-generation business, however, so management forecast that the final dividend was likely to return to 'at least' 4 cents.

Beautiful one day, down the next?

Despite the good news in the result, we're less sanguine about the next six months, and increasingly beyond. There's some risk that house price weakness migrates to states other than New South Wales and Victoria, thereby making it harder to sell premium ads in the 'emerging markets' of Queensland and South Australia.

Domain doesn't provide explicit earnings guidance but uncertainty among property sellers seems set to continue for the remainder of this year. In October we suggested EBITDA of $105m-110m for 2019, but $100m seems more likely now. Earnings growth in 2020 might also not be as strong as market expectations.

After Friday's jump, the stock has an enterprise value of almost $1.6bn (comprised of its market capitalisation of slightly under $1.5bn plus net debt of $121m) - about 16 times the $100m of EBITDA we're expecting for 2019.

We think Domain is good value on an enterprise value to EBITDA multiple of around 14, and we're therefore reducing our Buy price from $2.50 to $2.25 and our Sell price from $4.50 to $4.00 (we also won't be surprised if the stock falls back after Friday's 'relief rally'). However, we remain positive on Domain long term, particularly as the benefits from having Nine Entertainment as a 59% shareholder are yet to arrive. With the share price having jumped, we're downgrading to HOLD.

Disclosure: The author owns shares in Domain Holdings and Nine Entertainment.

Note: Our Model Growth Portfolio owns shares in Domain Holdings.