A weak trading update amid softness in the Australian property market and a slowdown in housing turnover has forced Morningstar to cut the fair value estimate for property listings business Domain.

Despite this, Morningstar analyst Gareth James says the long-term investment outlook for Domain Group (ASX: DHG) remains intact, noting that advertising on the listing portals domain.com.au and its rival realestate.com.au, owned by REA Group (ASX: REA), comprises a relatively small share of the total real estate marketing spending despite adding much value to the sales process.

James has lowered the fair value estimate for Domain, which carries a narrow moat, by 10 per cent to $2.80 a share following a weak trading update for the first four months of fiscal 2019.

housing Domain listings property real estate

A drop in new property listings is weighing on Domain

Shares in Domain were down by more than 7 per cent in afternoon trading on Monday at $2.56 - down on the $2.77 James quoted in his note published this morning, and which he considers as fairly valued.

"The key issue facing Domain is the weak Australian real estate market but more so the sharp slowing of real estate turnover and associated drop in new listings," James says.

"We expect the weak financial performance to continue until mid-2019 and that earnings per share will fall by 39 per cent in fiscal 2019, which is much worse than our previous forecast for 12 per cent growth.”

Home prices nationally have fallen 2.7 per cent since peaking in September last year, according to CoreLogic. Capital cities have led the losses, falling 3.7 per cent, while regional areas had a 1.2 per cent gain over the past 12 months.

The losses have been most acute in Sydney, with prices off 6.1 per cent, followed by Darwin at 3.7 per cent, Melbourne (3.4 per cent) and Perth (2.8 per cent).

James puts the house price weakness down to several factors, including the relatively high house price-to-income ratio, multi-decade low interest rates, and a tightening in credit following the banking royal commission.

The revised fair value estimate implies a “relatively high” fiscal 2019 price-to-earnings ratio of 50, which reflects James’s expectation of a sharp rebound in revenue and profit margins in fiscal driven by a rebound in listings.

James expects Domain’s relatively high exposure to the Sydney and Melbourne markets will drive sharper earnings downturn and rebound than for REA, which is majority-owned by News Corp Australia.

However, he notes Domain is in a strong position to weather the downturn because of its low debt and the cash-generative nature of its business.

Monthly real estate sales in Australia’s capital cities are tracking around 23,000 a week - their lowest level in 20 years despite a 34 increase in the Australian population over the period, according to property data firm CoreLogic.

However, Morningstar expects the population to continue growing at about 1 per cent a year "for the foreseeable future”, which is tipped to support a similar growth rate for Australian dwellings.

"Domain is increasing its share via growing sales of relatively expensive premium listings and we expect this trend to continue," James says.

 

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Lex Hall is a content editor for Morningstar Australia, based in Sydney.

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