REA Group and Carsales.com are two of the most profitable companies on the ASX due to network effects and their pricing power as the leading online property and auto classifieds portals in Australia. Both are mature businesses investing offshore in order to restore growth premiums to their share prices. Both are fully valued by the market but would be interesting at prices which undervalue the domestic businesses and ascribe no value for offshore investments.
Over the last five years profitability as measured by normalised return on equity (NROE -- includes franking credits), averaged 62 per cent for REA and 78 per cent for Carsales.com, higher than the long-term 14 per cent average for all ASX-listed companies. Over the same period REA grew revenue and earnings at respective compound annual rates of 10 per cent and 65 per cent while Carsales.com’s revenues and net income compounded at 20 per cent and 25 per cent respectively.
Both companies grew quickly because they built competitive advantages as print advertising moved to digital. Low capital intensity and the operating leverage of platforms have seen consistent net profit margin expansion. REA and Carsales.com benefit from ‘network effects’ where they maintain the most listings, which attracts the most buyers, leading to more listings and so on. Listing volumes alone do not sustain the circle. Continued investment in additional features assisting sellers and buyers is required to maintain real estate agent or car dealer relationships and respective leads in consumer engagement. The net result is REA and Carsales.com have become the largest and most active market for property and auto sales.
Almost all properties are sold through real estate agents who target high turnover to earn a reputation in the marketplace and ensure repeat and referral business. Realty is highly fragmented, so individual agents lack bargaining power and are inclined to undercut competitors on agency fees, affording REA substantial pricing power as the leading property portal.
Carsales.com’s leadership results from its relationship with dealers, so shares of dealer inventories and revenues are key metrics to track. The hurdle for competitors is dealers use Carsales.com’s technology for inventory management – Autogate -- which supports their operations. The dealer industry is also fragmented and highly competitive and individual dealers operate on slim margins. Many dealers do not have the means to use two services at once for long.
Agents who do not list on REA and dealers who do not list on Carsales.com risk falling behind their competitors.
There is little room to build on existing subscriber bases. REA has around 9,500 agent subscribers from an available pool of 10,000 and Carsales.com has 3,200 dealers out of a potential 3,700 to 4,000. Price increases are important revenue drivers. Future pricing power depends on maintaining leadership in listings and consumer engagement.
A recent aggressive marketing campaign by competitor Domain closed the gap in listings and subscribers. Agents were enticed with free 12-month subscriptions, discounted prominent listing products and shadow equity structures. Domain now has nearly the same number of agent subscribers as REA and its volumes are 80 per cent of REA’s, up from 62 per cent two years ago.
Carsales.com maintains a lead over direct competitors in car ads despite recent attempts by Carsguide.com.au and Drive.com.au to take share through aggressive free advertising initiatives. The main threat is from general online classifieds site Gumtree.
Competitors’ increasing share of listings volumes is a threat but will not necessarily disrupt pricing power. To increase their share of online advertising revenues competitors must convince free/low-paying subscribers their platforms will increase the speed and probability of sales and increase subscribers’ competitiveness against other agents or dealers, otherwise existing subscribers will not pay for and or renew contracts.
The key point is REA and Carsales.com lead competitors by a large and widening margin in consumer engagement metrics.
REA’s share of total time spent on property sites grew from 60 per cent in FY12 to 85 per cent in 1H15. The company now has 2.4 times the views per listing as Domain, up from 1.3 times at the start of 2012.
Carsales.com enjoys 94 per cent share of time spent on sites, around 31 times its nearest direct competitor (Carsguide). Carsguide’s average session times and total sessions have declined over the last six months. REA and CAR should be able to maintain market revenue shares at around 80 to 90 per cent, and grow revenue by charging more for more prominent ads.
The outlook for REA and Carsales.com also depends on the performance of their respective international businesses. REA’s include iProperty Group in Asia and Move.com in North America, and Carsales.com has iCarAsia, Webmotors in Brazil and SKENcarsales in South Korea. While these businesses are promising, they are not expected to contribute materially to group earnings for a number of years.
For REA we derive an equity multiple of 11.8 times, FY15 valuation of $45.56 and FY16 valuation of $57.14, with value growth above 24 per cent for the next two years.
Figure 1. REA adopted valuation metrics and future value
Source: StocksInValue
For CAR we derive an equity multiple of 11.6 times, FY15 valuation of $10.20 and FY16 valuation of $11.20 and value growth of above 10 per cent.
Figure 2. CAR adopted valuation metrics and future value
Source: StocksInValue
By Jonathan Wilson, Equities Analyst. StocksInValue provides valuations and quality ratings of 400 ASX-listed companies and equities research, insights and macro strategy. For a no obligation FREE trial, please visit StocksInValue.com.au or call 1300 136 225.