Why REA Group Limited just SHOCKED the market

Shares in online property business REA Group Limited (ASX: REA) are up more than 4% in morning trade after the group revealed a 14% lift in Australian revenue growth, despite property listings falling 8% for the quarter ending September 30 2016. This is an unexpected result to the upside and speaks to the wide reach and quality operating metrics of perhaps Australia’s strongest digital business.

Overall the group lifted earnings 9% to $90 million over the prior corresponding quarter, although free cash flow was significantly down partly as a result of greater interest expenses due to the debt the group took on to acquire its Asian doppelganger The iProperty Group.

This is an impressive result and one likely to be warmly received by the market over the week ahead after nervous investors sold the stock after REA Group’s rival Domain (owned by Fairfax Media Limited (ASX: FXJ) reported flat revenues and an expectation for falling earnings for the six months ending December 31 2016.

It’s worth noting that Domain is probably far more leveraged to weaker Sydney and Melbourne property listings than REA Group, which has a wider geographic reach and fee streams across Australia and internationally.

I expect property listings to return to more normal (seasonally adjusted) listing levels through 2017, which means the outlook for REA Group and its earnings growth looks good to me.

One concern I have around REA Group is how its newly-acquired iProperty Group of businesses is performing as the latest update noted “excluding the impact of iProperty, we expect the rate of full year revenue growth to exceed the rate of cost growth”.

REA Group coughed up around $750 million in total for iProperty on the basis of some big growth expectations and failure to justify the price tag could be a major drag on the share price in the years ahead. On the other hand iProperty could start to excel given time, so its performance remains on a watching brief for now.

I sold my REA Group shares for around $57 in August 2016 as I was rightly concerned the low level of property listings in Australia would drag the company’s performance and share price lower, although I was able to buy back the shares just above $46 last week after investors sold the stock on the back of the Domain result.

Can anything stop REA Group?

REA Group’s high return on equity means it’s is an unsurprisingly popular stock with investors and now that the worst of the listings plunge over the first half of financial year 2016 has washed through the share price I expect it will receive plenty of support from forward-looking investors going into 2017.

It seems that not even the lowest property listings in 21 years can stop the REA Group juggernaut its dominant competitive position, scalability, and leverage to the potent asset class of property means I think the shares look a buy at $51.90.

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Motley Fool contributor Tom Richardson owns shares of REA Group Limited.

You can find him on Twitter @tommyr345

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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