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Morningstar | Domain Holdings' Fair Value Estimate Maintained at AUD 2.80 Despite Guidance Downgrade

We weren’t particularly surprised or concerned that narrow-moat rated Domain Holdings used the annual Macquarie Equities conference to downgrade its fiscal 2019 earnings guidance. It’s no secret that the Australian real estate market remains weak, with CoreLogic reporting residential real estate price falls of 3.4% and 3.2% in Melbourne and Sydney, respectively, in the third quarter of fiscal 2019. However, as discussed previously, we expect the downturn to be cyclical and for real estate listings and Domain’s profits to eventually rebound. We continue to expect a real estate rebound in fiscal 2020, but even if this is delayed to fiscal 2021 it’s unlikely to impact our long-term view.

Domain’s flat third-quarter digital revenue growth implies a sharp slowdown on the 7.5% growth recorded in the first half and is well below the 22% average annual growth rates achieved over the past three years. The 6% fall in total revenue is also materially worse than the flat growth recorded in the first half and the 12% growth achieved in fiscal 2018. We already assumed a slowdown in revenue growth in the second half of fiscal 2019 but now expect group revenue to fall by 3% in fiscal 2019 rather than 1%. Our EBITDA decline forecast has fallen to 18% from 15%.

The 7.5% share price fall that followed the announcement indicated the market was surprised by the weak third-quarter earnings. However, as our forecasts were already relatively pessimistic, our downgrade is too immaterial to impact our AUD 2.80 fair value estimate. At the current price of AUD 2.70, the shares remain fairly valued. Although the fiscal 2019 price/earnings ratio of 45 is relatively high, this multiple does not reflect our expectation of a real estate market rebound or the underlying growth trends we expect over the next decade. Despite short-term earnings weakness, we expect the capital light nature of the businesses model to facilitate strong cash generation and relatively low financial leverage.

Despite the short-term earnings weakness, we are encouraged that Domain appears to be making progress in that yield, or revenue, per listing is up strongly and revenue weakness is largely a function of lower listings volumes that are largely beyond Domain’s control. More importantly, the company should benefit in the long term from favourable trends such as population growth and growing listings, particularly as online listing fees are a relatively small proportion of real estate transaction costs but arguably create most of the value. We also expect Domain to close the gap with realestate.com particularly following the acquisition of Fairfax by Nine. Although print revenue appears to be falling at a rate of around 25% per year, the division only composes around 15% of group revenue and is gradually getting less relevant.