REA Group (ASX.REA) shares jumped more than 10% as it reported first-quarter results with revenue excluding mergers and acquisitions up 8% and EBITDA excluding associates up 12%.

Why it matters: Guidance was unchanged, despite the property market experiencing sharp price declines since the company last reported in August. Importantly, this included guidance for new buy listing volumes to remain stable, which is the company’s most important short-term profit driver.

  • We do not change our forecasts, as we expected new buy listing volumes to remain at their current, elevated levels, despite the weak property market. We expect listing volumes to remain elevated over the next two years. We think listings are around 10% above trend.
  • The elevation is driven by investors, who are discretionary sellers and typically act procyclical. When the market is very hot, like last year, or very cold, like currently, investors become more active, respectively, as buyers or sellers.

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

  • Unlike consensus, we doubt the company can raise prices by double digits for the foreseeable future as it intends to do and which is needed to justify the current share price. Such aggressive pricing is likely to draw regulatory ire, given fees are already comparative.
  • The company has already come under increasing regulatory scrutiny, as have overseas peers. We expect the company to miscalculate its social license to raise prices against a backdrop of falling property prices. We forecast only a 7% fee CAGR over our explicit 10-year forecast.

Listing volumes expected to remain elevated for REA Group

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 competitive 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 reversals of previously introduced land taxes.

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, especially against the backdrop of record-setting price falls in Australian residential property currently. 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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