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Morningstar | REA Group Defies Gravity with Stunning 1Q Result. See Updated Analyst Note from 08 Nov 2018

Our decision to downgrade our fiscal 2019 earnings forecasts for narrow-moat-rated REA Group in October, following the earnings downgrade by Domain and broader decline in the Australian real estate market, was hasty considering the strength of REA Group’s first-quarter result. We expected REA Group would be impacted by weaker listings and slower real estate turnover but the 17% increase in revenue in the first quarter demonstrates the company’s pricing power, underpinned by a network effect based economic moat. It also now appears that more real estate vendors are diverting their marketing budgets from to If correct, and if this continues, REA Group will further strengthen its position as the leading real estimate platform in Australia, although one quarter isn’t enough evidence to make that call just yet.

REA Group’s ability to generate 17% revenue growth in such a weak real estate market was stunning, considering listings were down 3% nationally and 8% in Sydney, and we have reversed our recent fiscal 2019 revenue growth downgrade. We now expect REA Group’s Australian business to grow revenue by 13% in fiscal 2019 with group revenue growth of 15%. Management has not provided earnings guidance but expects margins to expand in the first half and for the full year, which is in line with our forecast. However, as with our previous downgrade, the change isn’t sufficiently material to impact our AUD 59.00 fair value estimate as our long-term forecasts are largely unchanged. At the current market price of AUD 78.52, we continue to believe REA Group shares are overvalued.

As per usual, the quarterly result contained little information other than revenue and EBITDA figures for the group, meaning the underlying drivers of the result are unclear. However, considering the Australian business comprises around 90% of group revenue, we expect it was the main growth driver. Although the quarter benefited from the inclusion of Hometrack and an extra month of ownership in Smartline, we expect these benefits only boosted revenue by around 3%, implying organic growth was around 14%. Like recent comments from carsales.com, REA Group said their finance division, which we believe lacks a competitive advantage, was being impacted by the downturn in the real estate market and the Financial Services Royal Commission. However, we’re not too concerned about the potential negative impact of the finance division considering it only comprises around 3% of group revenue.