Montgomery: What's next for these Aussie jobs, auto and property plays?

Among these three darlings of the local tech sector - Seek (ASX: SEK), REA Group (ASX: REA) and Carsales.com (ASX: CAR) - only one blotted its copybook this earnings season, in the eyes of Roger Montgomery. And even then, Seek's “miss” against the expectations of the Montgomery Investment Management CIO and founder was marginal.

• The reason for Seek's "messy" FY21 result
• Network effects explained
• Potential property listings upside for REA Group
• A used-car crash could knock Carsales.com

The jobs portal marked a return to profit on Tuesday, management reporting $752.2 million in net profit after tax for fiscal 2021 versus a loss of $113.1 million a year earlier. This sees the firm back in the black despite revenue that was weaker than forecast, particularly in its Australian and New Zealand operations.

“This result was messy, partly because of the restructuring of the company,” Montgomery says.

“There was a lot of moving parts in this result: The selldown of Zhaopin (Seek’s China-based jobs site) and the establishment of the investment fund.”

“From the perspective of individual divisions, the result looks reasonable but overall, it was pretty messy,” Montgomery says.

He maintains Seek remains an excellent business, with excellent long-term prospects despite the more immediate challenges and its current rich valuation. 

Seek shares traded at $31.65 at Wednesday's close, up slightly from Tuesday’s closing price of $31.30.

Alongside the other two companies discussed below, REA Group and Carsales.com, Montgomery ranks Seek among the cream of the crop of Australian companies, even if it's probably his least preferred of these three.

“These are extraordinary quality businesses that you'd place among the top 20 quality businesses in Australia, but prices are elevated so you do have to temper your enthusiasm for their prospects,” he says.

What is a network effect?

Before diving into the other company results and Montgomery’s views, you might wonder why we’ve grouped these companies together. In addition to being three of Australia’s most successful technology firms over the last 15-plus years, they’re united in each having strong network effects. 

Sometimes described as “marketplace companies,” such firms have a virtuous circle in the way their large audiences, or user bases, increasingly attract more users. They keep getting bigger because they’re already big. 

“The interesting question for each of these businesses is how successful are management at being able to replicate the kind of network effects that they’ve been anointed with by their customers domestically,” Montgomery says.
“For all three, the next phase for them, with the exception of perhaps REA, really depends on the company and its management being able to replicate overseas the benefits of the network effect they’ve enjoyed domestically.”

Listings lift: a matter of when not if

REA Group, which is a long-term holding of Montgomery’s funds, is (probably unsurprisingly) his pick of the trio. In the first week of this reporting season, the real estate portal - which is 60% owned by News Corporation (ASX: NWS) - announced $313 million in NPAT, which was slightly below consensus, mostly due to high tax rates. Earnings and revenue of $556 million and $927.8 million were up, gaining around 13% year-on-year.

Given the volatile market environment of fiscal 2021, Montgomery believes REA has held up well.

“It was just a slight miss at the NPAT level, so I think the outlook for that business is great if you look out further than three years. But I think the market looks a little shorter-term than that, so consequently, there’s a lot of difficulties understanding what it’s going to look like for the next 12 months or so,” he says.

“Management’s ability to raise prices is the key to why they’re so successful. In future, if we get any upturn in listing volumes, the ability to leverage that will be phenomenal. But for the moment, it’s almost impossible to place any certainty on the forecast.”

Property listings cliff dive: What it means for REA Group

“It’s like any market period: you have a period of indigestion or a hangover after there’s been a boom,” says Montgomery.

He describes it as something of a “chicken-and-egg” scenario, where potential sellers are reluctant to sell because they’re concerned about their prospects of finding another property.

“What comes first? I think people will renovate and then test the market, and if there are any concerns property prices might start to come off, that could spur people to list,” he says.

“If we get that increase in listings, that could become a virtuous circle. But you really need some sort of trigger to get those listings going.”

Source: SQM Research

The other consideration is the question of when immigration into Australia will pick up again.

“That could really give prices another kick up, which would potentially tighten the market even further,” Montgomery says.

“REA is a good business, it will continue to do well in the absence of an increase in listings, but it will really make hay if it can raise prices and leverage that increase in listings.

“Longer term, we expect that long-awaited normalisation of listings volumes will occur, and when that happens, it will give the company a massive boost.”

But Montgomery emphasises a timeframe is impossible to predict - a point also laboured by REA's management in the latest result. "All the uncertainty surrounding listing volumes at the moment plus the looming 2022 Federal Election is making it tough to know how strong a result it can produce (for first-half 2022)," he says.

REA Group stock traded at $156.43 at the close on Wednesday, down from its closing price of $159.42 on 6 August, the day FY21 results were announced.

Can used-car prices keep climbing?

The results from Carsales.com is the only “beat” among the three stocks in question, according to Montgomery – though he currently only rates it a hold rather than a buy.

Underpinned by the strength of its international businesses - the company’s auto classifieds websites in South Korea and Brazil recording solid growth in fiscal 2021 - Carsales.com reported NPAT of $130.7 million, up 9% on a year earlier.

The company’s recent 49% acquisition of Trader Interactive, a North American online caravan, truck equipment and motorbike listings group, also contributed. But the jury’s out on how this will affect the company longer-term.

“The last quarter, annualised, that business is at about $80 million EBITDA compared to $60 million for the full calendar year 2020, so it’s growing strongly, but the extent to which they can grow and how meaningful they are as a competitor really depends on the competitive landscape, and only time will tell,” says Montgomery.

And he’s even more sceptical about the sustainability of inflated used car prices that have resulted from COVID’s stranglehold on supply chains.

“They’re selling for 50% more than last year – on average – and some car prices have doubled. I don’t expect that to be sustained,” Montgomery says.

“The strength in the used car market has allowed Carsales to raise fees for private ads. I doubt they’ll be able to do that again because second-hand auto prices are unlikely to keep climbing as much as they have.”

Montgomery also addresses this in the context of the supply struggles that have plagued new car dealers and their customers since COVID hit - for example, one of my Livewire colleagues has waited more than eight months for a new Toyota.

“If the new car market remains challenged for any longer than 12 months, then all of the compensation (for Carsales.com) has to come from the global businesses and some sort of serious strength in digital retailing, along with the Trader Interactive acquisition,” he says.

If lockdowns and border closures continue, he doesn’t see another leg up in second-hand car prices of anywhere near the 20% needed to keep offsetting the weakness of new car sales.

“Carsales has had a really good re-rate recently. Some analysts believe it might have a bit of upside left, but it might only be 10% from here, so I’d give it a “hold” rather than a high conviction “buy”.

The wrap-up

The share price valuations of Seek, REA Group and Carsales.com, three of Australia’s most mature marketplace companies, are each well above their pre-pandemic levels. As online service providers, they’re each insulated – to varying degrees – from the pandemic fallout. But as Montgomery explains, they’ll each benefit greatly (as we all will) once normality returns – though he believes REA Group has the most to gain from a less volatile, post-COVID macro-environment.

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