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Why the McGrath Ltd share price could fall further

House Prices

Despite the ‘optimism’ shown by brokers Bell Potter and JP Morgan for McGrath Ltd (ASX: MEA), the share price of the real estate company is headed nowhere but lower.

Bell Potter and JP Morgan are the only two brokers covering the company – no surprise really given they were the joint lead managers (JLMs) and underwriters on the McGrath IPO. Bell Potter has retained its ‘Buy’ recommendation on McGrath, but has lowered its price target (following the share price) to $1.50, down from $2.25 last week. JP Morgan also kept its ‘outperform’ rating and lowered its price target to $1.60 from $2.20.

In an ill-timed report last week, Bell Potter analysts stated that McGrath was cheap when compared to overseas peers – seemingly forgetting that McGrath is leveraged to the Australian property market, unlike offshore real estate companies.

And it’s the swooning Australian property market that has driven McGrath to cut its prospectus forecasts as we wrote earlier this week. The biggest concern is that the slowing property market will continue to slow as house prices fall, and the impact that will have on McGrath’s earnings going forward.

Using the updated (lower) forecasts for the full year and comparing them to the first half results, McGrath’s second half of the 2016 financial year look awful.

Revenues could fall between 13% and 18%, while earnings before interest, tax, depreciation and amortisation (EBITDA) will be down between 16% and 23%.

half year actual new FY16 forecast Difference ($m) Difference (%)
Revenues $74.9m $136m $140m $61.1m $65.1m -18% -13%
EBITDA $14.7m $26m $27m $11.3m $12.3m -23% -16%

Source: McGrath half year report, my calculations

If the property market remains subdued over the next six months or so, McGrath could see revenues and earnings continue to plummet.

Even the RBA has warned about an oversupply of apartments, particularly in Sydney, Melbourne and Brisbane. “This new supply may weigh on prices and rents in these areas. If that occurs, investors will need to service their mortgages while earning lower rental income and any households facing difficulties may not be able to resolve their situation easily by selling the property,” the bank says.

Foolish takeaway

The McGrath share price may look cheap, having dropped by more than 50% from its IPO price, but it can still get cheaper from here.

Look out below.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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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