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REA Group — A stock for a national obsession

Australians love buying houses, with some two thirds of householders owning their homes and houses ‘turning over’ about every 10 years. Australians also love the Internet, spending an average of 33 hours a week online. Combine these two great Aussie passions and you’ve got the ultra-successful REA Group (ASX: REA) and its flagship website Realestate.com.au.

For investors, there’s much to love about this company. But mind the price tag on the shares.

A fantastically successful business

So just how successful is ‘ultra successful’, you ask? Brace yourself for a few more stats: Locally, Realestate.com.au sees nearly 21 million visits a month, and Australians spend 74% of their total real-estate web viewing time on Realestate.com.au. More than two million Australians have downloaded the app, and traffic through the app grew some 200% in 2013.

For all this talk of web and app traffic, keep in mind that the company doesn’t make money directly from consumers. Its customer base is primarily property groups, property owners and real estate agents who subscribe to and pay to advertise their wares on its sites. Connecting these advertisers (and others, such as lenders and homewares brands) to the house-mad consumers who frequent the sites is REA Group’s bread and butter.

This business model is beautifully capital light — and beautifully heavy when it comes to margins and profitability. Between 2006 and 2013, the company’s net margins expanded nearly twenty percentage points, from 13.6% to 32.6%. So, during this seven-year period, net profits rocketed from $6.6 million to $110 million, at a compound annual growth rate of 50%. (Sales grew from $60.4 million to $337 million over this time as well, for a compound annual growth rate of 28%.)

As the market matures, the company’s growth is moderating somewhat, but not grinding to a halt by any means. For this past fiscal year, overall sales grew 21% and net profits increased 26%. Notably, for the first time in the company’s history, listing product revenue – which saw growth of 49% — surpassed subscription revenue. In other words, there still looks to be some gas left in the tank. But, as with buying a home, making sure you don’t overpay is key!

International opportunity

REA Group doesn’t just operate Realestate.com.au, but a number of real-estate related websites the world over, including Casa.It in Italy, Squarefoot.com.hk in Hong Kong, and a business serving Luxembourg, France and Germany.

These sites contribute to the company’s overall one billion page views each month; and these international properties contributed some 11% of sales in fiscal year 2013.

Risks & valuation

One danger to look out for is REA Group possibly overpaying for acquisitions as it seeks to keep up its blistering growth. The company has long had a growth-by-acquisition strategy – just look at the international properties — and is in a good place to make further acquisitions today, with zero debt and its $260 million war chest. (And the company could conceivably make quite a large acquisition with the backing of majority shareholder News Corp.)

That’s no guarantee of a favourable price however, and with great capital comes great temptation. An expensive acquisition may not be in the best interest of shareholders, still, it’s unlikely to sink the ship. And the company’s further expansion overseas also has to be viewed in light of how it will mitigate some of the risk of REA Group eventually reaching a ceiling in the Australian market.

One almost wishes that REA Group would make acquisitions with its own shares, as they are simply stonkingly expensive — the valuation equivalent of a Sydney waterfront mansion. Shares currently trade for a whopping 15 times sales, 50 times trailing earnings, and at 35 times enterprise value to operating profits. Oof.

Foolish takeaway

You’ve got to love REA Group’s business (not to mention the simple pleasure of trawling Realestate.com.au for a couple of mindless hours!). It’s capital light and highly profitable. The one thing it isn’t, however, is cheap. By all means, put this stock on your watch list. In the event of a steep pull back, it might be time to hit the buy button.

More reading

Motley Fool writer/analyst Catherine Baab-Muguira doesn’t own shares in any companies mentioned.

 

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