REA Group’s (ASX.REA) full-year results showed both revenue and EBITDA up 12% on the prior year, excluding the exited India business. Dividends per share were up 20% to $2.97.

Why it matters: The company saw significant acceleration through the fourth quarter. Listing volumes increased 11% during the final quarter compared with a year ago, following a softening housing market due to rate hikes by the Reserve Bank of Australia and the introduction of tax changes for real estate investors.

  • We expect this acceleration to continue as investors typically act procyclically, meaning they hold on to properties when prices are rising and become more interested in selling when prices are falling. Given ongoing price falls, we expect above-trend listing volumes for the next two years.

The bottom line: We increase our fair value estimate for narrow-moat REA Group to $130 per share, reflecting the time value of money. At current prices, REA Group shares screen as materially overvalued.

  • We question the long-term growth prospects for the company. The company is already by far the dominant website in Australia and enjoys EBITDA margins of 66%. We also think continued double-digit price hikes are bound to draw the ire of regulators, especially if property prices continue to fall.

Between the lines: We think it is becoming more shareholder-friendly, with a renewed focus on the profitable Australian market and on capital returns.

  • We think that after several decades of unsuccessful overseas expansions into Europe, Southeast Asia, East Asia, and South Asia, it is now becoming apparent to the company that overseas expansions don’t work because of the network effects inherent in property portals.

A More Shareholder-Friendly REA Group, but Growth Runway Is Limited

We expect REA Group’s near-term challenges to center on navigating significant regulatory and competitive tension. REA Group has come under increasing regulatory scrutiny for anticompetitive behavior, which we find understandable, given the dominant position it holds and the steep price hikes it puts through every year, both from direct price hikes on existing tiers and through the introduction of new listing tiers, which we consider price hikes by a different name. The acquisition of competitor Domain by CoStar, and its intention to increase competition, adds to near-term challenges, although it mitigates regulatory scrutiny.

In the long term, we expect a gradual decline in listings due to friction in the housing market caused by ongoing increases in transaction costs in the form of stamp duty, and to a lesser extent, REA Group’s own listing fees. Total dwelling transactions in the Australian housing market declined for nearly two decades until the onset of the pandemic, despite the number of dwellings increasing around 1.7% per year over the period. We attribute this falling liquidity principally to rising stamp duty, which has increased around fivefold in the past two decades. We do not forecast a significant reduction in stamp duties, despite some state governments undertaking initiatives to replace the upfront stamp duty with an ongoing land tax. We do not believe any Australian state is in a sufficiently financially healthy position to be able to afford this transition, as evidenced by their deteriorating credit ratings and as evidenced by recent state governments’ decisions to raise property taxes and remove previously introduced land taxes. We therefore forecast a continuing decline in housing stock liquidity.

We expect REA Group’s long-term growth to be primarily driven by growth in yield, or listing fees, within its residential division. We see limits to these price hikes from societal friction and regulatory tension. In the long term, we don’t believe competitive pressure poses a significant limitation on the company’s pricing power.

Bulls Say

  • REA Group and Domain effectively operate a duopoly in residential real estate listings in Australia, and REA Group is the dominant platform of the two.
  • REA Group has demonstrated its ability to defend its competitive lead over Domain where it matters most, in audience size, revenue, and margins.
  • REA Group’s deep relationship with corporate parent News Corp provides it with access to some of Australia’s most popular newspapers, websites, and television channels.

Bears Say

  • REA Group’s earnings are affected by the housing market, which is highly cyclical.
  • AI-curated shortlists based on user prompts could diminish the value of REA Group’s list-based search and tiered pricing model.
  • REA Group is attracting increasing regulatory scrutiny and has been under investigation.

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