REA Group Limited (ASX: REA) operates Australia's leading property portal, www.realestate.com.au, with 94% of all properties listed for sale in Australia advertised on realestate.com.au.
It attracts more than 43 million website visits per month, which is more than double that of its number two competitor, Domain, as a subsidiary of Fairfax Media. Moreover, its acquisition of iProperty Group early in 2016 gives it an exciting foothold into the Asian market. iProperty operates leading property portals across Malaysia, Thailand, Indonesia, the Hong Kong region and Singapore.
REA Group makes its money through the number of listings advertised on its property portals multiplied by the length of time a listing is advertised. If the property sector were to experience a downturn, REA could well come out unscathed and possibly even be in better shape than before. Why? Because in a property downturn it takes longer to sell a property.
We know two things will always occur in a slowing property market. Firstly, people will still need to buy and sell real estate, for numerous reasons, and people will still have to advertise the sale of their property regardless of the environment. Furthermore, in a slowing property market REA would still have the power to increase its prices.
What I like most about REA is that it possesses tremendous pricing power, operating virtually a monopoly where it can raise its prices with there being very little effect, if any, on demand for its services.
The first place any person goes, who's looking to buy or rent a residential property, is realestate.com.au. In some cases, it's the only place people go, so much so that their advertising slogan says: "If you're not on realestate.com.au, you're simply not in the market."
So, if REA were to raise its average listing price by say 10 percent, real estate agents would have no choice but to pay for the extra increase in price.
Here in Australia, digital real estate advertising, makes up circa 65 percent of the real estate advertising industry. Incidentally, I would expect this figure to continually increase over time as print advertising becomes more obsolete.
In Asia, however, digital real estate advertising makes up for less than 15 percent of the Asian real estate advertising industry. As more Asian countries become more developed, I would expect this number to increase substantially over the next decade or two.
REA is a sound business in every sense, the exact type of business I look to own. It has superior economics, with favourable long-term prospects in Australia and abroad. It generates high returns on equity capital and is run by honest and able management. It also has little debt and generates solid cash flow. What's more, this business has been positioned by its management to benefit from the future tailwinds that its industry will experience here in Australia and abroad.
Foolish takeaway
Assuming REA can grow its earnings at an average compounded annual growth rate of between 12.5 percent and 15 percent per annum over the next decade, and then grow its earnings perpetually at 5 percent per annum over its life time, I estimate REA Group's intrinsic value lies somewhere between $59.55 and $72.18 per share.
Based on today's share price of $53.88 , REA shares are currently trading at a discount to its intrinsic value of between 15 percent and 26 per cent. This represents a great opportunity to buy a piece of a wonderful business.
