We raise our fair value for wide-moat REA Group REA to $126 from $123 following first-half results. The company has outperformed our expectations, as Australia is seeing continued new listings growth, despite listing levels last year having already been significantly elevated compared with long-term trends.

REA Group estimates that new buy listings were around 8% higher during the first half, compared with the previous seven-year average. However, we believe this seven-year average itself also represents somewhat elevated levels, as it included the booming housing market period of fiscal 2021-22. Regardless, new listings growth slowed during the half, from 12% above the seven-year average in the first quarter to just 3% in the second quarter. We therefore continue to forecast a normalization, albeit at a slower pace. We have adjusted our immediate near-term forecasts up and pushed back our normalization to fiscal 2026-27. Our forecasts assume a gradual normalization and don’t include a potential increase in listings from distressed selling.

At current prices, REA Group shares continue to screen as materially overvalued, at nearly double our fair value estimate. The market seems to assume the company will be able to continue raising prices in its Australian residential business without constraints. We agree that the company does not have competitive constraints, as it essentially operates a duopoly with narrow-moat Domain and has extended its leadership position over Domain in recent years.

REA has hit peak earnings with few avenues for growth

We expect REA Group’s near-term challenges to center around navigating significant volatility in the Australian housing market. After the onset of the covid-19 pandemic, REA Group received a substantial boost to revenue and profit margins from the booming housing market. We estimate that residential transactions were around a third above trend levels during fiscal 2021 and 2022. With the normalization of interest rates, we expect continuing swings in listings but an eventual return to trend, which started in fiscal 2023.

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. 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 five-fold 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 evidenced by recent state governments' decisions to raise property taxes and remove previously introduced land taxes. We therefore forecast a continuing decline in housing stock liquidity.

We expect REA Group’s growth to be primarily driven by growth in yield, or listing fees, within its residential division, rather than from market share gains. REA Group’s market share versus Domain in terms of audience has remained largely unchanged in recent years and we consider the competitive environment to be stable. Instead, we expect REA Group and Domain to focus on increasing revenue per listing through price increases and through increased depth penetration.

REA bulls say

  • REA Group, together with Domain, effectively operates a duopoly in residential real estate listings in Australia and REA Group is the dominant platform out 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.

REA bears say

  • REA Group’s earnings are affected by the housing market, which is highly cyclical.
  • REA Group has incurred large losses from its international divisions, and many have been disbanded. REA Group’s India division is currently still highly unprofitable.
  • REA Group is attracting increasing regulatory scrutiny.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.