It is no secret that the Australian property market is cooling, particularly in Sydney and Melbourne, as residential property prices are generally expected to stagnate in the coming months and years.
It may seem counterintuitive, but the cooling property market could actually benefit online real estate listing sites like Domain Holdings Australia Ltd (ASX: DHG) and REA Group Limited (ASX: REA), as property sellers are forced to invest more into marketing to sell their properties, with increased housing stock to compete with (and fewer buyers), lower auction clearance rates and a longer average time on the market for residential properties.
These trends could force sellers to spend more on their Domain.com.au or Realestate.com.au listings; such as through premium placements, through a multi-channel strategy (e.g. utilising both print and online media), or as a result of listings staying online for longer (therefore, costing more on average). It is important, however, that the property market is buoyant enough to provide Domain and REA Group with ample listings to generate strong revenues. In essence, a balance is required between the number of listings on their site and the average customer expenditure per listing.
While there is uncertainty regarding the future growth of property listings over the next 12 months, it is arguable that this optimal balance in the market is currently being achieved, which may explain why both Domain and REA Group are up by about 8% over the last 6 months, diverging from the returns of the Australian property market.
Where to invest? Domain or REA Group?
Both Domain and REA Group operate solid digital business models. However, unlike Carsales.Com Ltd (ASX: CAR), which operates in a quasi-monopoly in online car classifieds, they compete in what is essentially a duopoly in online real estate listings.
In its FY18 results, REA Group reported EBITDA of $464 million, 22% stronger than FY17, while Domain reported EBITDA of $116 million, 12.5% higher than last year.
It is my view that REA Group currently operates a superior business for the following reasons:
- In recent years REA Group has consolidated its market share to 75%, while Domain has slid to 25%, giving REA Group the dominant market position.
- At present, REA Group operates more efficiently, with an EBITDA margin (Earnings before interest, tax, depreciation and amortisation/revenues) of 52%, which the company has considerably improved over time, while Domain operates with an EBITDA margin of just 24%. Therefore, REA Group is currently more profitable and enjoys a higher return on capital than Domain.
- REA Group has exhibited strong and prudent management, which has a proven ability to consistently grow profits over a long period of time; while the stability of Domain’s management is still questionable after the resignation of its former CEO early this year, less than 3 months after its spin-off from Fairfax Media Limited (ASX: FXJ).
Therefore, I believe REA Group is your best bet for getting exposure to the online real estate listings industry. REA Group is a solid company that I’d love to own at a price of $70 or so, but while the company is trading at a price-to-earnings ratio of 38x, I will happily stay on the sidelines awaiting a minor downward market correction.
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Motley Fool contributor Gregory Burke has no position in any of the stocks mentioned. The Motley Fool Australia has recommended carsales.com Limited and REA Group Limited. 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 Scott Phillips.