Domain: Result 2018

Domain's 2018 numbers were always in the bag. Had this newly listed digital real estate group missed market expectations it would not have been a good start to listed life.

We were, in fact, hoping the result might turn out a little better than it did. However we're paying a much lower multiple for Domain than market leader REA Group, which reported its results on Friday, so the Fairfax spin-off is entitled to a little more leeway.

When we commenced coverage of Domain before it listed last year, we expected 2018 revenue of $360m and earnings before interest, tax, depreciation and amortisation (EBITDA) of $116m. As it turns out the company produced revenue of $357m and EBITDA of $116m, up 12% and 13% respectively on last year.

They're decent enough numbers but we were hoping for something more inspiring. Revenue came in slightly lower than expectations due to some weakness in Victoria. REA confirmed on Friday that it had taken market share in the Garden State during 2018.

The place to be?

Domain put this market share loss down to operational issues – perhaps related to staffing changes in the Melbourne office – and was very confident of making up ground this year. Melbourne will need watching, however, as Domain can't afford to put fires out in traditional markets while it expands into newer ones.

EBITDA of $116m was smack bang in line with our original expectations but the composition was poor. Cost cuts in the Print division resulted in flat EBITDA there despite an (expected) 13% decline in revenue. But it's revenue growth rather than cost cuts that should be driving an online-focused business like Domain at this stage of its corporate life.

While we're getting things off our chest, it was disappointing – but not overly surprising – to see Domain already reporting writedowns on investments. Stakes in online marketplaces Beevo and OneFlare always looked like potential distractions, and Domain has chosen to exit the former and write the latter down to the tune of $12m.

In the end these are small gripes. The fundamental reasons why we upgraded Domain after Antony Catalano resigned remain the same.

First and foremost, Domain is selling more premium listings, just as expected. Premium ad penetration rose in every single state except Victoria, proving that Domain's sales teams are doing their jobs well. Selling more premium ads in cities outside Domain's Sydney stronghold is a key reason to own the stock and, with the supposedly temporary exception of Melbourne, everything is going swimmingly.

As the Crows fly

We were surprised by the strength of South Australia in particular, with management highlighting the branding deal with the Adelaide Crows as very successful. Queensland remains the state with the most potential, although it's an REA stronghold and will likely be a slower burn for Domain.

It's worth noting that Domain's growth in other states won't necessarily come at REA's expense; the company simply needs to convince real estate agents that REA's dominance in cities outside Sydney isn't in their long-term interests. That shouldn't be a hard sell.

It's also worth reiterating that it's listings that drive revenues for Domain (and REA) – not house prices. Similar to REA, Domain noted that July listings were weak compared to the previous period, particularly in Sydney.

There were early signs of a recovery in August, so it would be premature to call the spring selling season a dud just yet. But there remain risks that 2019 listings could be affected by vendor hesitance or election uncertainty.

Earnings up, house prices down

Domain's revenues and earnings will certainly rise again in 2019, even though house prices in Sydney are likely to continue falling. Listing price rises, the ongoing shift to premium ads, and geographic expansion will be the drivers once again. These should be long-term themes even though listings will swing about from year to year.

Our recently lowered Buy price of $2.75 represents a 2019 forecast enterprise value to EBITDA multiple of 13 (based on expectations of EBITDA around $130m). Any listings weakness could provide a chance to upgrade again, as might any decisions by incoming chief executive Jason Pellegrino. New chief executives can shake things up, so management risks need to be borne in mind.

Nevertheless, we remain comfortable with Domain's story and progress. The growth potential means the stock isn't particularly expensive despite the high price-earnings ratio. HOLD.

Note: The InvestSMART Australian Small Companies Fund owns shares in Domain Holdings. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Domain Holdings.