Is the REA Group Limited (ASX: REA) share price a buy?
The real estate property portal business saw its share price fall 43% from 21 February 2020 to its low of $65 on 23 March 2020. Since then it has risen 64% to today's $106.60.
Where to now for REA Group? It's being priced as though conditions have almost returned to normal.
The worst of the COVID-19 period across Australia saw a severe drop in the number of property listings, as you'd expect.
FY20 third quarter
When REA Group announced its profit for the quarter ending 31 March 2020, the company also revealed that residential listings were down 33% across the country with Sydney showing an 18% fall and Melbourne with a 27% fall.
Obviously REA Group is quite dependent on volume for generating its earnings. And the earnings should be important for the direction of the REA Group share price.
In that third quarter of FY20, REA Group said that national listings were down 2% over the three months due to COVID-19. This led to revenue after broker commissions dropping 4% to $640.2 million, operating earnings before interest, tax, depreciation and amortisation (EBITDA) falling 3% to $390.8 million and free cash flow declining 14% to $195.2 million.
REA Group did what it could to offset the problems such as 'digital inspections' with digital video tours and 3D tours.
However, some measures that the company announced will cause lower earnings in the short-term. It gave customers subscription discounts and also increased the advertising duration which will extend the revenue recognition period. However, cost reductions will help with offsetting the revenue reduction. FY20 fourth quarter operating expenses are expected to be 20% lower than the fourth quarter in FY19.
Balance sheet
Many businesses have had to do a capital raising to ensure that their balance sheets remain strong during this tough period. But these capital raises have been done at a low share price, which dilutes existing shareholders. Raisings from the likes of Webjet Limited (ASX: WEB) and Qantas Airways Limited (ASX: QAN) were necessary but existing shareholders will now only get a smaller share of the earnings when they recover.
Thankfully, REA Group hasn't had to raise capital because of its strong balance sheet. At 30 April 2020 it had low levels of debt and a cash balance of $135 million. It also entered into an additional $149 million debt facility as well as a $20 million overdraft facility with National Australia Bank Ltd (ASX: NAB).
In short, REA Group is in a great financial position and shouldn't need to raise capital.
So is the REA Group share price a buy?
A balance sheet is important for a business, but it isn't the main thing in my opinion. Apple has a fantastic balance sheet, but there's more to Apple than its huge cash pile.
The renewed Melbourne lockdown will make it harder for REA Group to bounce back quickly if listings remain lower in Victoria for the next few months. The Sydney property market could also come under pressure if COVID-19 gets out of control there.
REA Group is now trading at 44x FY21's estimated earnings. I don't think that represents good value in the current share market because it relies on there being a return to normal listing activity. If there are numerous forced property sellers over the next six months due to jobkeeper and payment holidays coming to a close thenperhaps REA Group may see that required activity bounce.
But the combination of lower listings volume and more attractive listing options for vendors makes me believe that, at today's share price, I don't think REA Group is going to be a market-beating buy in the medium-term. If I had to go for something property related it would be Brickworks Limited (ASX: BKW).
