Hispanolistic
Compass, Inc. (NYSE:COMP) has been under enormous pressure since trading at a little over $19 per share on May 3, 2021, and since then plummeting to $2.21 per share on Sept. 26, 2022.
The company, after positioning itself as a tech company operating in the real estate sector, took a hit on both fronts first, because the market punished risky tech stocks in light of expected increases in interest rates by the Federal Reserve, which meant downward pressure in margins and earnings, and in the case of real estate, the same high interest rates lowered demand because of the higher cost of mortgages.
Another issue the company has in my opinion is its primary focus on its agents. While management has stated it has worked on lowering compensation for some, it still appears to be an unsustainable business model, as evidenced by its weak performance when the real estate market was hot.
In this article I want to focus most on where the company stands today, as it faces at least two to three more interest rate hikes from the Fed. That points to the first half of 2023 being a hard one for COMP as it struggles to shrink losses and turn cash-flow positive, something I don’t see happening anytime soon.
The Tech and Fed effect
There are two major things that are having a negative impact on the share price and performance of COMP, and they are the fact the company positioned itself in the past as a tech company that is competing in the real estate market.
When sentiment turned negative against high-growth tech companies, COMP got punished with them because of the DCF model which is used by analysts to project future earnings for companies. That is a major headwind because it expects a decline in future earnings and cash flow as a result of rising interest rates which results in more expensive capital.
A similar thing happens in the real estate market in relationship to higher mortgage costs associated with the ongoing increase in interest rates.
My view is this is going to get worse before it gets better. There should be at least three more interest rate hikes, including one in January 2023. At that time we’ll get a much clearer picture of the intention of the Fed for the remainder of 2023.
I don’t think the Fed will go beyond the 5 percent mark on interest rates because of the huge $31 trillion in debt held by the U.S. government. Much higher than that and it would be extremely difficult for the government to meet its payment obligations. For that reason, either the Fed will stop a little below 5 percent, or at worst, a little above that.
As this relates to COMP, it’s going result in an even tighter real estate market as demand will continue to slide. No matter how much real estate agents are compensated, they can’t create demand that isn’t there. That was confirmed by a drop in the number of transactions per average principal agent from 6.2 transactions in Q2 2021 to 5.2 in Q2 2022. While those aren’t actually bad numbers, it’s probably going to get worse before it levels off.
Cost-cutting Measures
In its last earnings report management said a lot about the need to cut costs going forward. The CEO, COO and CFO repeated that as a key part of the company’s main operational strategy in the months ahead.
Management reminded investors that in the prior earnings report, in order to lower costs, the company “paused all expansion into new markets and discontinued M&A activity.”
The CFO at the time, Kristen Ankerbrandt, also pointed out the company began the process of reducing its workforce by 10 percent, along with “other” cost-cutting measures. The goal is to cut “non-GAAP operating expenses after commissions and other expenses to $1.05 billion to $1.15 billion” by the end of 2022. Ankerbrandt said that would lower its LTM Q2 2022 levels by $320 million from the $1.42 million it had at the time.
As of the end of June, the company had $431 million of cash and cash equivalents on its balance sheet.
I didn’t want to repeat the general earnings numbers in the last quarter because they’ve aged, and the next unconfirmed earnings report is expected to be on Nov. 9.
The next earnings report will be important because the Federal Reserve will have raised interest rates again by then, and will do so again in early December.
Coming pressure
COMP spent approximately $900 million to build its tech platform. It asserts that the “heavy investment period” is now behind them. The question in my mind is if cost-cutting is too little too late in light of the environment the company is now operating in, and which isn’t going away any time soon.
As mentioned above, there will without a doubt be at least two more interest rate hikes, including November and December. Depending on the size of those hikes, there will likely be one more in January 2023 before the Fed may decide to take its foot off the pedal.
What that means for the share price of COMP is that it will probably come under more pressure, even after its drop to a 52-week low of $2.21. There’s nothing in company guidance that would point to there being support at about the $2.00 share price mark.
By the end of 2022 we could see the share price drop to near the $1.00 level. Beyond that, it will depend upon if the company can in fact reach positive cash flow in 2023 as it asserts it can do. If it does, it would be later in the year, because demand for housing is going to continue to decline, probably through the end of 2023. A caveat there is if the Fed decides to cut rates at significant enough levels to trigger more demand from home buyers in the second half.
The other unknown is how severe the recession is going to become, or if it’s going to be a modest and short one.
Either way, COMP is going to be under pressure for some time, and it doesn’t look like it’s going to be able to sell enough homes to overcome that.
Recent hires and recruits
Since the last earnings report CFO Kristen Ankerbrandt has left the company and been replaced with Kalani Reelitz, who will begin his duties on Nov. 15. Most of Reelitz’s experience came in senior roles at Cushman & Wakefield Americas.
On the recruiting side, the company landed the “Fishkill-based Home Team from Berkshire Hathaway Home Services.”
The 11-person team sold about $62 million in real estate via 185 transactions in 2021, making it the 11th in New York in sales when measured against large teams.
As for the new CFO, I don’t see him, at this time, having any immediate impact on the company one way or another. Under current conditions the path has already been laid out, and other than ensuring the strategy is executed on the financial side of things, there isn’t much more he can do.
As for poaching the team from Berkshire Hathaway Home Services, it makes a good headline, but the results the team produced was in more favorable conditions than it now faces. Over time it could be beneficial to the performance of COMP, but it’ll take time for that to be proven.
Conclusion
COMP is going to struggle over the next several quarters, and depending on its ability to execute its cost-cutting plan and reach positive cash flow in 2023, it could get in trouble if it falters.
There are questions concerning how much difference its tech platform makes, and while it is a market leader, building out the platform has resulted in the company not producing results that generate a profit.
The other thing a number of investors have questioned is its agent-focused model. While there is obviously merit to taking care of the people that generate revenue for you, at the same time it’s the customer that pays the bills, and there isn’t much talk lately about home buyers. I’m not sure it’s a red flag, but it’s somewhat odd that little is mentioned of the people they’re selling houses for and to.
Taking it all into account, it seems to be the company probably has overextended itself in relationship to growth at all costs, and now that the real estate market is going to be under a period of prolonged pressure, it’s going to take strong execution to work its way out of the hole it dug itself.
If it is able to execute and generate positive cash flow in 2023, it could turn the ship around and surprise to the upside. That would definitely trigger a nice upward move in its share price.
But as the company stands, it’s far more likely it’s going to struggle through 2023. In the near term, after the next couple of interest rate hikes, the share price is likely to collapse further in light of a declining real estate market.
Be the first to comment