Is REA Group Limited set to beat the market in 2016?

Credit: John St John

REA Group Limited (ASX: REA) was one of the first cabs off the rank during this month’s reporting season. However, the market reaction could best be described as muted, with the share price neither appreciating strongly or falling through the floor after the first half numbers were released.

Taking a longer term view, REA Group shares are up over 35% from the lows it experienced in June last year. However, the 12-month view shows that the shares are only up around 6% from this time last year. Which begs the question, is REA Group still capable of outperforming the market in 2016?

The bull case

The bull case for REA Group is easy to make. The website, is undoubtedly the number one property portal in Australia, something that not even its closest competitor,, disputes. and have similar amounts of properties for sale or rent on their respective portals, however, the similarities beyond that are limited. logs more some 24 million more visits per month than Domain. In addition, the audience spends more time five times the amount of time on versus

In internet businesses, this is referred to as the dominant network effect. More buyers mean more sellers, and vice versa. Such strong audience metrics mean that both buyers and sellers are willing to pay a premium to advertise on the site, and REA Group is well aware of this fact.

To monetise this advantage, the company has begun to shift its billing much more heavily towards “depth” advertising products, which give property agents selling homes for their clients the opportunity to highlight or pin their property to the top of search results, in exchange for paying premium prices. REA Group bills the agent, who in turn, will typically pass on the majority of the cost and bill their client.

REA Group also has a credible international growth profile, with the purchase of iProperty Group, which operates real estate advertising portals across south east Asia. It also has operations in Europe and a minority stake in the portal in the United States.

The bear case

However, REA Group has an outsized exposure to one industry: the housing sector in Australia. While everyone in the country has an opinion on property prices, it would be difficult for REA Group to escape the short-term headwinds that would come from any material slowdown in the housing market.

Auction clearance rates in Sydney and Melbourne already have well and truly come off their highs, which some believe is a warning sign that property prices are set for a period of stagnation. Housing price stability or short term falls both mean that the turnover of housing stock is lower, and that translates to less houses listed on, which in turn means less revenue.

In addition, REA Group must pass on price increases to property agents in order to grow its earnings and margins. There has been a history of agents revolting at perceived unfair increases, and Domain may take advantage of any discontent to reduce its own prices in order to win market share. Being such a distant number two may incentivise Domain to take more risky steps in order to win market share, and a large group of property agents acting in concert to avoid could pose a risk to revenues.

There is also execution risk arising from the international expansions. Attitudes towards property and housing are not uniform across the world, and market dynamics differ greatly. For example, in the United States, there are buyers agents and sellers agents who each take a commission, while there are many subtle differences in attitudes toward housing in Asia.

Foolish takeaway

There are many reasons to get excited about REA Group, and the company is perennially on my watchlist for that reason. However, it is difficult to see it becoming any more dominant in Australia than it already is, and there are some potential dangers on the horizon for it at home, at a time when management will also be fully occupied integrating its multiple international operations. I believe REA Group could be a growth stock for future years, but there may be better options out there at current prices.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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