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Why I think the REA Group share price is a buy (and hold)

The REA Group Limited (ASX: REA) share price fell 3.9% in the first 10 minutes of trade on Friday 8 February, dropping to $74.88, before finishing the day at $74, or 5% beneath the opening.  This came after the company announced a 98% fall in net profit in its first half 2019 results. At first glance, it seems like challenging times for the realestate.com.au owner.

In addition, recently appointed CEO, Owen Wilson, unveiled flagging residential listings amidst global regulatory focus on cooling property markets.

This included listing declines of 7% in Malaysia, 13% in Hong Kong and 3% in Australia during the first half of FY19. Mr. Wilson also gave cautionary statements about the near term – particularly for the Australian market where the upcoming federal election and the regulatory response to the Royal Commission present downside risk.

Why, then, should you buy REA Group shares now (and hold them)?

In addition to being partial to the Rothschild aphorism of: ‘when there’s blood in the street, buy property’, things aren’t as grim for REA Group as they appear at first glance – maybe it is time to buy property (technology).

Firstly, REA Group has been able to continue to grow revenue in Australia – accounting for 91% of revenue – despite falling numbers of listings through enhancing product mix and introducing new services. Indicators of user satisfaction from REA Group’s platforms is also impressive and improving.

Risks for the business include global expansion execution, regulatory pressure on the financial industry, and governmental focus on house prices. However, REA Group will continue to benefit from its position as gatekeeper to the real estate market. The company has successfully implemented new product and revenue lines that bodes well for future growth.

Secondly, the 98% reduction in net profit for the first half of FY19 was driven by impairment to Goodwill from its Asian unit which covers Malaysia, Hong Kong, Indonesia, Thailand and Singapore. Macroeconomic deterioration led to a (presumably once off) $173.1M lowering of intangible assets.  Excluding such one-off costs, REA Group’s results were resoundingly positive.

The company has shown repeated ability to post double-digit growth, an impressive feat for a business steadily closing in on $1B of annual revenue (and facing headwinds in key drivers). For the first half of FY19, revenue of $469.2M was up 15%, and EBITDA of $289.1M was up 19%, on the first half of FY18. Regionally, REA Group achieved double-digit revenue growth across Asia (14%) and Australia (16%), quite a feat for a business trending towards annual revenue of $1B (although this rate of growth is moderation on FY18).

Finally, REA Group’s midday share price on 15 February 2019 is still at a 16% discount to its 20 August 2018 peak of $94.12. Due to robust earnings and a languid share price, REA Group’s price-earnings ratio is about as good as it’s been since FY15. For reference, the iPhone 6 was released in the first quarter of that financial year.

Looking at historical price-to-earnings (P/E) ratios following full-year announcements for FY16, FY17 and FY18, 12-month trailing P/E ranged from 39x to 40x. This contrasts with 12-month trailing P/E of 32x at the time of the H1 FY19 results (34x at midday 15 February), a notable improvement in affordability.

While forward-looking management expectations show tempered (still double-digit) growth out to FY20, REA Group remains a high growth, high margin business that is well-positioned in the Australian property market, with beachheads in foreign markets.

Foolish Takeaway

Risks, perceived and otherwise, have left REA Group with a price-to-earnings ratio that hasn’t been seen in over 4 years. There is no guarantee that REA Group is going back to 40x P/E, however, when some vibrancy does return to the property market, REA will be a good stock to be holding.

While there is some uncertainty ahead, the quality of the business and track record of strong growth make a compelling case for picking up some exposure, particularly to hold into the longer term.

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Motley Fool contributor David Fulham has no position in any of the stocks mentioned. The Motley Fool Australia has recommended 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.

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