1 INDEPTH RESEARCH NOTE REA Group Ltd Neutral Price: A$72.97 Price Target: A$74.80 ASX: REA 12 February 2018 REA s first half FY18 (1H18) result was underpinned by strong growth in the Australian business and its new Australian financial services business off to a solid start. Relative to the previous corresponding period (pcp), group revenue ($406.8m), EBITDA ($242.8m) and EPS (111.8 cps) all increased by +21% over the half. REA s core value driver the Australian business delivered revenue and EBITDA growth of +21% on the back of depth growth and favourable listings in Melbourne and Sydney. We are attracted to REA s (1) market leader position in Australia; (2) growth opportunities via diversification of segments and international opportunities; and (3) the potential step change in earnings from the new Financial Services segment. With Australian listing volumes still a little weak, we prefer to remain Neutral on the stock. 1H18 result release key points. (1) The Group revenue growth of +21% is attributed to a +21% increase in the Australian business revenue, and the inclusion of Financial Services business revenue, which was not included in the prior comparative period. (2) The Board has declared an interim dividend of 47.0 cents per share fully franked, representing an +18% increase on pcp. (3) Australia - Residential listing depth revenue increased 21% to $295.6 million, driven by the success of Premiere All offering and increased yield despite falling listing volumes. (4) The Asia segment saw revenue up +19% and EBITDA up +70% on pcp, driven by My Fun, Thailand and Indonesia.
2 Sydney & Melbourne driving Australian volumes. Australian revenue grew +21% to $384.0m, with inclusion of Financial Services segment revenue for the first time of $13.2m. Improved depth penetration driven by REA s Listing depth strategy saw Developer and Commercial listing depth and subscription revenue increase 5%. Management noted that total residential listings were marginally down during the half, (however) listings grew in the key markets of Melbourne and Sydney, providing some upside to Australian volumes and residential listings for the second half. Financial Services segment ahead of expectations. In 1H18, REA delivered the first set of results for the Financial Services business, generating revenue of $13.2, and EBITDA of $5.7m (including share of losses of associates). Since the launch of realestate.com.au Home Loans, there have been over 5.3 million engagements with the Mortgage calculator and 150,000 financial profiles saved by customers with the first home loan settlements occurring throughout 1H18. The Smart line acquisition was completed on 31 July 2017 and the purchase consideration of $67 million was funded from existing cash reserves. In September, REA acquired a 70% non-controlling share of the mortgage broking business realestate.com.au Home Loans Mortgage Broking Pty Ltd, a NAB owned subsidiary, which will be accounted for as an associate within the Financial Services segment. Strategic investment in North America close to be a positive contributor. With revenue growth of +17% in 1H18, the North America segment is close to be a positive contributor to group earnings, with the drag in 1H18 primarily related to amortization of acquired intangibles. The US tax reform resulted in a one-time $11.8m deferred tax adjustment which was recognised within share of losses for the period. FY18 Outlook. Although management did not provide specific guidance, they expect to see normal seasonality of revenue with stronger first half revenue than second half revenue. The decline in new project commencements is expected to continue which will impact revenue growth in the Developer business. It is expected that (excl. Financial Services) revenue growth will exceed the rate of cost growth however not in Q3 due to different timing expense impacted by an earlier Easter (EBITA growth rate will be lower for this quarter as a result).
3 FIGURE 1: REA REVENUE BY SEGMENT FIGURE 2: REA EBITDA BY SEGMENT
4 Investment Thesis We rate REA as a Neutral for the following reasons: Leading market position in online property classifieds, with consumers spending over 7.2x more time on realestate.com.au than the number two website in 1H18. Growth opportunities via expansion into Asia and North America. Recent strategic partnerships with National Australia Bank (property finance) should be positive in the long. Upside in key markets. New product developments to increase customer experience. Key Risks We see the following key risks to our investment thesis: Competitive pressures lead to a further de-rating of the PEmultiple. Volume (listings) outlook remains subdued in the near term. Execution risk with Asia/North America strategy. Failing to get an adequate return on the recent acquisition of iproperty. Value/EPS destructive acquisitions. Decline in Australian property market. Given REA trades on a very high PE-multiple, underperforming to market estimates can exacerbate a share price de-rating. Company Description REA Group (REA) is one of Australia s leading integrated energy companies and the largest ASX listed owner, operator and
5 developer of renewable energy generation in Australia. The company sells and distributes gas and electricity. Further, it also retails and wholesales energy and fuel products to customers throughout Australia. The business operates four main segments: Energy Markets, Group Operations, New Energy and Investments. 1H18 results summary FIGURE 3: REA 1H18 GROUP HEADLINE NUMBERS VERSUS PCP 1H18 group results. Group revenue grew +21% to 384.0m in 1H18 on pcp and EBITDA grew +21% to $253.6m on pcp. Management attributed strong growth of group results to the strength of the core Australian business, which has been boosted by a more positive residential listing mix. Australia. The Australian business recorded revenue growth of +21% to $384.0m for 1H18, with agent numbers increasing +5% on pcp. (1) Australia s listing depth revenue increased +21% to $295.6m driven by the success of the Residential Premiere All offering and increased yield, despite a decrease in overall listing volumes. Although listing volumes were marginally down, management noted that residential listing volumes in key markets Sydney and Melbourne were up. (2) Developer and Commercial listing depth and subscription revenue increased +5% due to strong growth in Commercial and improved depth penetration. (3) Small decreases in Developer revenue were
6 attributable to the decline in new project commencements in 1H18, despite offsets by longer durations for Project Profiles. (4) The new Financial Services segment generated revenue of $13.2m and EBITDA of $5.7m including associate losses from newly acquired NAB brokering subsidiary. Asia. The Asia business performed well, considering subdued market environments in Malaysia and Hong Kong with property transactions down -7% and -13%, respectively. Despite this, continued investment in Asian markets resulted in revenue growth of +19% on pcp to $22.8m and EBITDA growth of +70% on pcp to $4.5m. REA continues to be the market leader in Malaysia, with an increase in the Singapore market position to number 2, and a strengthened market position in Indonesia with 48% increase in visits. North America. With revenue growth of +17% in 1H18, the North America segment is close to being a positive contributor to group earnings, with the drag in 1H18 primarily related to amortization of acquired intangibles. The US tax reform resulted in a one time $11.8m deferred tax adjustment which was recognised within share of losses for the period. Cash flow. There was a reduction in the cash position due to funding of new investments, especially in the Asia business and repayment of debt in the new Financial Services segment. The cash balance fell to $198.3m from $358.5m during 1H18. FIGURE 4: REA 1H18 GROUP EBITDA GROWTH (A$M)
7 FIGURE 5: REA FINANCIAL SUMMARY Recommendation Rating Guide Total Return Expectations on a 12-mth view Speculative Buy Greater than +30% Buy Greater than +10% Neutral Greater than 0% Sell Less than -10%
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