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Cage Match: Limited vs. REA Group Ltd

The introduction of the internet, as well as its gradual increase in speed and adoption nationally has transformed how business is conducted. This is no more evident than in the transition of classifieds from print to online media, which has propelled the fortunes of major players such as Limited (ASX: CAR) and REA Group Ltd (ASX: REA).

Recent volatility in the market has brought both companies close to their 52-week lows, so now might be a good time to pick up these growth companies at a reasonable price. But which one is the better pick?

Operating environment

REA is the market leader in online real estate advertising with nearly 93% of all residential property listing in Australia, ahead of its closest rival Domain at 67% share. It generates revenues by charging agents a monthly subscription fee for access to its platform, and tiered property listing fees based on the level of exposure provided.

Carsales is just as dominant in the Australian new and used car classified market, with revenues a mix of monthly subscription fees from dealers and a fee for each sales lead generated. Just like REA the company has an advertising arm attracting business from related industries (i.e. accessories, insurance), and also generate revenues from ancillary offerings such as financing and dealer and data services (i.e. inventory management for dealers).

Financial summary

Being the market leader in their respective markets has given both companies substantial pricing power as users are reluctant to leave the platform in favour of another with less exposure.

This translates into exceptional profitability, with Carsales and REA notching up five-year EPS growth at a CAGR of 25.5% and 35.6% respectively. It also means that both companies have very strong balance sheets with minimal debt.

Not only have shareholders been richly rewarded in capital gains, they’ve also been on the receiving end of increasing dividends. Carsales is the more generous with a dividend yield of 3.6% against 1.5% of REA, but on a relative basis it is also more risky because its payout ratio is higher (81.5% vs. 44%).

Growth Outlook

Both companies are looking for growth in overseas markets.

REA will be exposed to Asia’s fast-growing property market through its substantial stake in iProperty Group Ltd – Asia’s top ranked online property group with market leading positions in Malaysia, Hong Kong and Indonesia. It is also looking to break into the US market through its 20% holding in Move Inc, the country’s third-largest online property group.

Carsales is targeting growth in Asia and Latin America through its stake in iCar and Webmotors. Both are exhibiting positive signs as they each registered double-digit visitor growth in first half 2015.

Of course, the domestic market will also be another source of growth given the pricing power both companies yield.

What to do?

Valuation wise neither company looks cheap clocking in at P/E of 28x for REA and 22.6x for Carsales, but they trade at a premium because of their growth potential. Both companies will benefit as internet speed increases, allowing more content (i.e. videos) to be included in classifieds. It is also quite likely that they can rollout their successful domestic model to international markets.

Although both companies appear to be pretty even, I would say Carsales is a slightly safer investment.

As pointed out before by writer Mike King, REA has opted to reduce subscription fees in a bid to earn a larger slice of real estate agent commission by relying more heavily on its tiered listing fees. This reduces the level of recurring revenues and will make earnings more volatile. Further I believe the dealer and data services division will make Carsales earnings more secure.

Given the high volume of transactions put through Carsales’ portfolio of sites, data analytics (i.e. how to improve online sales efficiency) will be a major differentiator in a sluggish market. More importantly this data allows the company to sell expertise, creating cross sale opportunities and enhancing the value of its platform to customers should online classified become commoditised in the future.

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Motley Fool contributor Simon Chan has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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