We have long been supporters of the REA Group (ASX: REA) story with the company a longer term holding in both our domestic and global funds. Initially we were attracted to the very high rates of return on equity and little or no debt – a function of the company’s dominant position and its ability to charge higher prices even after a decade of competitors offering the same service for free.
As you would already know we think the most powerful competitive advantage is the ability to charge a higher price for your good or service, without a detrimental impact on unit sales volume, even in the face of excess supply. And there is no question that with something like 80 websites in Australia offering real estate listings, there’s no shortage of supply.
When many believed that the company’s fortunes were tied to real estate prices, our analysts understood that it was listing volumes and time-on-market that determined revenues for REA.
And even under a scenario where property prices peak and begin to decline, we believe REA is positioned to grow revenues and profits significantly. This is because a booming property market does not lend itself to rising property listings, as many properties sell without ever being marketed through regular channels. Indeed, since 2011 the total number of Australian residential listings has actually declined in the order of 21 per cent. During this period however REA’s revenues and earnings have risen by 20 per cent per annum.
If the property market comes off the boil, the number of listings will rise and vendors try to cash in and secure the price their neighbour achieved a few months ago. Buyers however will pull back because there is more choice. The net result is lower auction clearance rates and longer times ‘on market’. This all means more revenue for REA.
In addition to the above sources of revenue growth for REA, the company will also benefit from raising its prices and increasing its ARPU (Average Revenue per User) through what is known as ‘mix-shift’. Vendors, keen to sell amid a growing number of listings, will need to feature their property. To do so they will have to secure the Premiere and Highlight ad options offered by REA.
According to the latest numbers from REA, at least some of our thesis appears to be playing out. Paid depth ads (the name given to all the ‘feature’ ads) were up circa seven per cent in the last quarter. And according to our friend Ivor Ries at Morgans stockbrokers, Highlight listings last week were 53,707, 0.6 per cent below the same time last year but the more expensive Premiere listings totalled 31,247, 25.5 per cent higher than the same week last year. “As Premiere listings are significantly more expensive than Highlight listings, the mix shift towards Premiere should more than offset any revenue loss incurred from lower Highlight volumes.”
Importantly, the trends on which our thesis is based are now being observed by a wider band of sell-side researchers. One of them now expects, thanks to price rises, Premiere ad revenue growth of about 50 per cent in the first quarter of FY2018, amid Premiere volume growth of an estimated 34 per cent. Premiere ad volume growth in September was actually 33 per cent, despite total listings being up – as we expect – but by just 2 per cent. The same broker also expects REA to report depth revenue growth of 35-40 per cent in 1Q18, ahead of their hitherto forecast of 34 per cent for FY2018.
We remain content with our REA holding, and an upper valuation that is currently higher than the current traded price. In an expensive market, to find value right under our nose can be a rare thing.
The Montgomery Funds and Montgomery Global Funds own shares in REA.
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