Downward pressure from the residential property market has caused the REA Group Limited (ASX: REA) share price to drop 19% from its all-time high.
What's happened?
You may not have heard of REA, but you will certainly know the company's flagship property website. Realestate.com.au is Australia's largest online property portal. REA has also acquired international property sites within the North American and Asian markets.
REA makes money by selling advertisements to property vendors and real estate agents. Three levers help REA to grow its revenue and earnings: a greater number of listings; longer advertising campaigns; and a swing towards premium and highlight ads. Real estate prices have little to do with how much revenue REA earns. As the property market strengthens, more and more properties are sold off-market or run shorter advertising campaigns. This provides a headwind to REA, as we have seen over the last few years. Despite this, REA has managed to grow EBITDA at double-digit rates since 2010.
The current slowdown in the Melbourne and Sydney property markets provides an opportunity for REA to grow its revenue and earnings. This is aided by the stricter lending policies of the big banks, as a result of APRA's regulation. As auction clearance rates fall and credit becomes harder to find, vendors and agents will have to:
- advertise more properties;
- purchase premier advertising packages; and
- re-advertise properties that don't sell.
REA is the biggest fish, in a huge pond. Including agent fees, the annual Australian marketing and sales costs for the residential property market is around $7.5 billion. In FY18 REA grew revenue 20% to $808 million and EBITDA 22% to $464 million. REA commands roughly 10% of the market. Being so large, the network effect comes into play. As sellers become more hurried and anxious, they will go to where the largest number of eyes are. Realestate.com.au is that place.
Growth stocks like REA are often hit the hardest when the market dips. The REA share price is further hurt by the current negative sentiment towards the property market. REA trades at 35x trailing earnings. This is well above the market average of 16/17x earnings.
Foolish Takeaway
REA is a quality company with a history of strong earnings growth and share price appreciation. The recent pull-back in the share price could present an opportune entry point for investors who are willing to ride out the near-term negative sentiment.
