A year makes all the difference (apparently). Investors were petrified by New Zealand’s dominant online classifieds company Trade Me as it plummeted towards its final results release in August 2015. Undeterred, our ‘Buy’ was about as forceful as we get. In Trade Me: Result 2015 we declared: ‘On a 2016 forecast PER of 16, the stock is one of our better buying opportunities’.
Since then, the share price has jumped 77%, including 5% yesterday (or 44% since our initial 2014 upgrade). But why was the market so excited by a paltry 4% increase in 2016 underlying net profit (see Table 1)?
Because profit growth will significantly improve from here. Indeed the story is unfolding exactly as described in Trade Me: Interim result 2016. While first-half profit was flat, the second half grew by almost 7%.
Potential from premium products
Profit growth to accelerate
Expense growth is moderating. Trade Me is hiring fewer staff, while the 104 employees it put on the payroll in 2015 are starting to earn their keep. Second-half expense growth was 17% but management forecasts a fall to around 10% in 2017. The mathematics of it means management has forecast 2017 profit growth will exceed that of 2016. We concur.
Just as pleasing is that revenue continues to motor upwards – by 9% as you can see from Table 1. But the company’s classified businesses produced 13% revenue growth in 2016, with the growth in ‘premium’ revenue especially pleasing. In Trade Me’s three classified segments of Property, Motors and Jobs, premium revenue grew 51%, 56% and 36% respectively.
This premium revenue is from a low base, indicating that Trade Me is well behind its Australian classified contemporaries when it comes to charging for premium advertisements. For example, premium revenue for Trade Me’s Property business comprises 23% of its total (up from 20% in the half-year to 31 December). By contrast, REA Group’s premium revenue – for its ‘listing depth’ products – is around 70% of its Australian total.
While differences in business models and industry structure help to explain the difference, there’s almost certainly significant upside for Trade Me Property – and Motors and Jobs too. We remain enthusiastic about the latent value in the Property division, particularly now that the company is focused on strengthening its relationship with the real estate industry and developing products to meet the needs of agents. Trade Me has learned the lessons of its 2014 stoush with the industry.
Trade Me’s laggard has been its General Items division (the New Zealand equivalent of eBay). But as management promised, this division is also stirring from its slumber. Second half revenues rose 7% – the first decent growth in three years – as product improvements drove listing volumes up 27%. While General Items is unlikely to produce growth anywhere near Trade Me’s classifieds businesses, the nascent recovery shows what a bit of management attention can do.
This time there was less focus on Trade Me’s ‘Other’ division, which is a miscellaneous collection of revenue sources and ventures that don’t fit anywhere else. Perhaps that’s the influence of the new chief financial officer but it could also be because some ventures are struggling.
|Year to 30 Jun (NZ$m)||2016||2015|| /(–)
|* 9 cent final dividend ($NZ), 100% franked (NZ only), ex date 8 Sep. Aust. shareholders also receive a 'top-up' dividend equating to c. 1.588 NZ cents, or c. 10.588 NZ cents in total.|
For example, the company wrote off $8m from its perfunctorily named online dating business FindSomeone (excluded from the underlying numbers in Table 1), while its recent insurance foray is off to a slow start. Overall, though, ‘Other’ revenue was up 8%, driven by good growth from display advertising (which accounts for almost half of segment revenue).
So what of the valuation? Well, despite being more positive than most, we too have underestimated Trade Me’s business. Our current $4.00 Buy price is way too low.
In our view the company should produce EBITDA close to NZ$160m in 2017. Combine that with the long-term potential to push premium pricing and we’re comfortable paying up to 14 times 2017 prospective EBITDA for the company. It’s a high multiple – and equates to a prospective price-earnings ratio of 25 – but we expect profit growth to accelerate.
Our new Australian dollar Buy price of $5.25 a share equates to a historical free cash flow yield of 4.5%. Trade Me is by no means the bargain it was a year ago, but it’s still reasonable long-term value given the growth potential.
Jobs and growth
Several risks could derail the investment case. Online classifieds are essentially just advertising businesses, so a New Zealand recession or even a minor economic downturn could see listings contract. Trade Me’s Jobs business is probably most at risk here but all its Classifieds businesses would be affected.
Then there’s the ever-present risk that a deep-pocketed new or existing competitor tries to take market share. While we judge this to be a relatively small probability any competitive incursion would be very damaging, even if Trade Me ultimately prevailed.
It’s also possible Trade Me could score an own goal with one of its new ventures. The company has invested in New Zealand peer-to-peer lending group Harmoney. Start-up ventures often end up consuming more capital than originally envisaged. A blow-out of losses here – from $1.6m in 2016 – wouldn’t completely surprise.
Taking all that into account, Trade Me is still attractive. If you’re new to the stock, we recommend starting with only half our suggested maximum portfolio weighting of 6%, which will allow you to top up if a better opportunity appears. Existing shareholders from past recommendations should sit tight, although bear in mind the 6% maximum weighting. Trade Me is a BUY once again.
Note: The Intelligent Investor Growth and Equity Income portfolios own shares in Trade Me. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: The author owns shares in Trade Me.