REA – The Growth Story is Over

REA released its Q1 FY23 results on the 9th November. Revenue and EBITDA grew 16% and 7% YoY respectively. Management continues to target full year positive operating jaws in FY23. The results seem solid and everything looks fine.

But is it really the case?

Trajectory of the quarterly EBITDA and margin might shed some light.

• Q1 FY22: $158m (+24% YoY) @ 59%
• Q2 FY22: $210m (+28% YoY) @ 64%
• Q3 FY22: $155m (+27% YoY) @ 55%
• Q4 FY22: $150.5m (+0.5% YoY) @ 50%
• Q1 FY23: $169m (+7% YoY) @ 55%

It is quite obvious that earnings growth is decelerating since Q4 FY22 and the margin also fails to maintain the 60% benchmark as in the past. So, what’s happening?

REA’s profitability comes from four line of businesses, namely

1. Australia – Property & Online Advertising
2. Australia – Financial Services
3. India
4. Equity-Accounted Associates (e.g. overseas investments)

Looking into each line of business:

Australia – Property & Online Advertising

As we know, this is the bread and butter of REA. In H1 FY22, YoY EBITDA growth was 29% and corresponding margin was 71%. FY22 year end report no longer provides EBITDA breakdown of this business but was combined with Australia Financial Services. We can still find out the top line revenue grew 19% for the whole FY22.

Q1 FY23 result announcement mention growth in listing volume, product price and depth/Premiere penetration remain versus last quarter. Assuming cost structure didn’t change significantly, I reckon the Australia Property & Online Advertising still delivered over 20% YoY EBITDA growth in Q1 FY23.

Australia – Financial Services

The Q1 FY23 report just states “Financial Services revenues declined in the quarter” without the exact figures. This is the Mortgage Choice business REA paid $244 million or $1.95 per share to acquire in 2021.

Mortgage Choice’s earnings per share dropped from 11 cents in FY19 to 7.5 cents in FY20 (-31% YoY). Before the acquisition announcement, Mortgage Choice was traded at $1.195 per share. Essentially, REA paid 26x PE ratio or a 75% premium of the market price to acquire Mortgage Choice as a declining business.

With high interest rate and mortgage becomes less affordable, Financial Services will continue to face strong headwinds and become a burden of the company.

India

The Q1 report says “REA India delivered strong revenue growth of 47% for thequarter…” but “Increased investment in REA India is expected to see EBITDA losses widen in FY23…”. Looking at the revenue growth trajectory:

• H1 FY22:$24.5m
• H2 FY22: $29.4m(20% Vs H1)

India’s economy was badly impacted by COVID till mid-2021. The Q1 FY22 (Jul-Sep 2021) results didn’t state the revenue of India business, it can’t determine whether the growth in Q1 FY23 (Jul-Sep 2022) is due to a low baseline in 2021. I’m looking forward to seeing the H1 FY23 revenue versus same time in FY22.

Though REA paid almost $100m in 2020 for the acquisition, India business will remain EBITDA negative and continue to drag the group’s profitability in the foreseeable future.

Equity Accounted Associates

There are three investment holdings in this line of business, namely Move, PropertyGuru and Other.

Move was acquired by REA and News Corp in 2014. It contributed to a total of $30m profit in FY21 & FY22.

REA invested $52m into PropertyGuru in 2021. PropertyGuru went IPO in NYSE in March 2022 for US$10 per share. Yesterday’s closing price was US$5.25 or equivalent to a 47.5% drop since IPO. REA had written off $6m in FY22 for this investment. If PropertyGuru’s share price continues to decline with the US market, more write off is possible.

In a nutshell, I think REA owns a highly profitable Property and Online Advertising business in Australia. However, the management made several acquisitions and investments between 2020-21 (Mortgage Choice, India Business & PropertyGuru) right before the world was moving from a loosening to a tightening monetary environment. The global tightening environment are strong headwinds for REA’s newly acquired businesses and will continue to drag the company’s profitability. This is not to mention the premiums already paid for making those acquisitions when the market was still hot. Those acquisitions turn out to be bad decisions as the management failed to anticipate a paradigm shift in the global economy.

The stock is currently trading at a 38x PE ratio (TTM). With a single digit to at most low double-digit earnings growth, PEG is much greater than 1 and the valuation is obviously too high. I won’t be surprised if the stock price continues to decline.