News & REA: Interim result 2018

Last year News Corporation managing director Robert Thomson made a promise that the company's online property division would soon be its most profitable. On Friday he delivered, with Digital Real Estate reporting underlying earnings before interest, tax, depreciation and amortisation (EBITDA) of US$214m for the six months to December, up 29%.

By contrast, the News and Information Services (NIS) division reported EBITDA of US$213m. Pipped at the post, you might say.

Of News Corp's five main divisions, though, it was NIS that surprised on the upside. You'll recall that this division is in decline, with earnings almost halving between 2013 and 2017.

What's encouraging about NIS is that the rate of decline seems to have slowed – at least for now. Underlying earnings for the half rose 4%, although cost cutting helped. Revenues – partly assisted by acquisitions and currency – grew at News UK, News Corp Australia and Dow Jones. Within Dow Jones, there are some excellent businesses that would fetch high prices if they were sold; the company pointed to ‘strong growth in its professional information business', for example.

Advertising revenues within NIS fell 6% but overall the outlook for the division seems a little less dire. Unfortunately insert and coupon business News America Marketing sullied the picture somewhat, with revenues declining 16%. Management expects something of a reversal this quarter.

Elsewhere, Book Publishing EBITDA rose 6%, while Cable Network Programming EBITDA fell 8%. The latter is being buffeted by costs related to the launch of a dedicated channel for the National Rugby League and the proposed merger of Fox Sports and Foxtel.

Speaking of Foxtel, EBITDA in the half lurched down 17% as higher sports programming costs took a toll. The merger of Foxtel and Fox Sports has been approved by the ACCC and is expected to complete in the current half.

Returning to Digital Real Estate, the division – consisting mainly of the 62% holding in REA Group and 80%-owned Move – continues to perform well. EBITDA rose 32% for the half. While News Corp doesn't disclose Move's profitability separately, it's consistently profitable at the EBITDA line and able to self-fund its growth.

REA Group continues to shine brightly, albeit with a couple of minor blemishes. In Australian dollar terms revenues, EBITDA and net profit each grew 21%, to $407m, $243m and $147m respectively. Mortgage broker Smartline generated almost $6m in EBITDA since being acquired in July last year and forms the basis of REA's new financial services division.

REA's Asian division was one of the blemishes, with revenue rising 19% to $23m in the half. But property transactions fell 7% in Malaysia and 13% in Hong Kong in the period, which makes the $500m-plus price paid for iProperty last year look rather steep. A writedown is possible.

Another, perhaps slightly more concerning issue is the one alluded to in News & REA: Result 2017. With apartment commencements falling, revenue from property developers is weakening – for both listings and display advertising.

This trend has only just begun and, as we expect this revenue generates high margins for REA, there's a danger that the property developer downturn may become a stronger headwind over the next year or two. Market concerns about this might eventually provide our long-awaited opportunity to buy REA Group but the stock remains a HOLD for now.

It's pleasing to see News Corp's Digital Real Estate division thriving, but it's equally reassuring to see less troubling trends emerging within NIS. It would however be a mistake to assume that revenue and earnings declines within NIS will reverse; more advertising revenue is likely to migrate elsewhere.

As we've previously stated, however, our valuation (see News Corp's American dream) already accounts for this. It's not inconceivable that Dow Jones alone is worth the $1.7bn of value we've ascribed to the NIS division in our base case.

Nevertheless, we prefer to remain conservative. At an REA Group share price around $75, our News Corp Buy price remains around $20 a share. We're not a long way from an upgrade but at the current price News Corp is a HOLD.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in News Corporation. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.