REA is well set for a strong quarter: Montgomery

If you’ve ever bought or leased a house – or merely browsed properties online – you’re probably familiar with realestate.com.au. The flagship website of REA Group (ASX: REA), it’s one of the best-known property websites in Australia - alongside that of Domain (ASX: DHG) - and continues to pull ahead of its rivals.

I spoke with Roger Montgomery, founder and CIO of Montgomery Investment Management, soon after REA announced an impressive half-yearly FY2022 earnings result on Friday.

• $226 million net profit after tax for the half-year ended 31 December 2021, up 30% on 1H21
• $368 million in earnings before interest, taxes, depreciation, and amortisation – 27% higher than a year earlier
• A record dividend of 75 cents a share, up 27% from the previous interim dividend of 59 cents.

Montgomery knows the company well, this year marking about a decade since he first bought the stock back in 2012.

“We rank it as one of the highest-quality companies in Australia, right up there with ARB Corporation (ASX: ARB), Reece (ASX: REH), Megaport (ASX: MP1), CSL Limited (ASX: CSL), Cochlear (ASX: COH) and those sorts of businesses,” Montgomery says.

REA Group comprises 3.4% of The Montgomery Fund portfolio, falling just outside the top 10 as of Friday afternoon.

Why does Montgomery like the company so much? In short, it’s because REA holds plenty of cash on its books, has only a small amount of debt and has an efficient and responsible management team.

REA's fundamentals are mostly immune

And despite incessant talk of an impending crash in property prices and the inevitability of interest rates rising, the company has still been able to increase the prices it charges clients (predominantly real estate agents) and keep boosting revenue.

That’s because the number one variable for REA Group is property listings, not the price of housing or mortgage rates. When Montgomery and I last spoke about the company following its FY2021 result, listings were declining.

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“Even then, the company’s ability to migrate customers to its premium listings products meant that even in that declining volume environment it was able to increase revenue pretty much annually. That’s an incredible testament to the popularity of its website and the durability of its platform,” he says.

“And we always knew that listings levelled out, not only do you get the increased margin from rising prices and the mix shift toward premium products, but you get a volume boost as well. They’re not going to lower their prices, so then everything drops to the bottom line.”

The inevitable lifting of the cash rate is not something REA fears because its business model is about activity in the housing market, not prices.

Are REA shares too expensive?

From around $175 in November, REA shares were trading at just over $140 at today’s market open.

“They’ve come off a long way, so it hasn’t been immune from the prospect of rising interest rates and that’s a function of the fact that when interest rates go up, the present value of a future dollar declines. All assets are affected,” Montgomery says.

“Whether or not it’s an overreaction is another thing. In these periods, investors often abandon their long-term investment plans with short-term fears about what’s going to happen to prices next week or next month."

“The baby gets thrown out with the bathwater so really high-quality businesses like REA get thrown out with what I call the ‘profitless prosperity’ stocks of business that aren't making any money."

Montgomery notes that the company is currently trading at about 16 times equity, which would classify it as expensive on a traditional PE measure.

“But investors need to understand this is a company that expenses much of its capital expenditure that it invests for growth. If the company wasn’t investing for growth, it would be generating a much higher return on equity,” he says.

“They can’t afford not to be on REA”

Monthly visits to the realestate.com.au website average almost 130 million, which is almost 3.5 times higher than the traffic volume of its nearest competitor Domain. And of these, around 6.6 million are exclusive to REA.

“They make it so compelling that If you’re a real estate agent, you can’t afford not to be listing properties on REA. It’s an industry driven by data, which helps agents campaign the properties they want to sell,” Montgomery says.

“So, if you want to reach that group, there’s no other way – you can only get them through REA.”

Outlook

During Friday’s earnings call, analysts quizzed REA’s management team, headed up by CEO Owen Wilson, about the company’s outlook for costs versus revenue.

Demonstrating his confidence in the team as efficient stewards of capital, Montgomery notes they “confirmed again – as they’ve done before – that they’re always targeting widening jaws, they want revenue to be growing faster than costs.”

“The reason they can target that is because a proportion of their workforce is contracted. They can turn off and turn on that workforce based on market conditions and the effect they might be having on their revenue.”

Property listings in January were incredibly strong – especially given it’s usually a slower month given the overhang of Christmas and the holiday period. Website visits of 125 million were just under the six-monthly average of just over 128 million.

“The company thinks, and we agree, that the next quarter to the end of March will be very strong,” Montgomery says. Though listings are up around 17% nationally since last August, he still sees plenty of growth in this volume before it can be said to have normalised.

This boost in listings is likely to slow again, albeit temporarily, in the fourth quarter of the 2022 financial year around the Federal Election.

“Listings always drop during an election, and you’ll also be comparing some very impressive numbers from the same quarter last year,” Montgomery says.

And beyond the domestic business, he also emphasises the long-term potential of REA’s property portals in Asia and India. The company owns an 18% stake in Singapore’s PropertyGuru portal and operates Housing.com in India, which in December achieved the highest number of visits of any domestic property website. 

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