I think that REA Group Limited (ASX: REA) could be one of the best growth shares in the ASX 100 alongside A2 Milk Company Ltd (ASX: A2M) and Xero Limited (ASX: XRO).
REA Group is the owner of Australia’s most popular real estate portal, realestate.com.au. It owns other property leading sites such as realcommercial.com.au too. It also has stakes in several other international property sites in the US, South East Asia and India.
Why I think the REA Group share price could be a buy
REA Group has been one of the best shares to own on the ASX over the past decade. The share price alone has risen by over 1,700% during the past 10 years, plus all of the dividends.
However, whilst I don’t think the next decade will be anywhere near as good, I think it could continue to beat the market despite the current housing price model:
Very strong brand for an essential service
If you’re looking to buy, sell or rent a property the first place you’re going to go is realestate.com.au. Being number one has a pleasing self-fulfilling trend where it attracts the most buyers, which then attracts the most potential sellers and so on.
According to REA Group, data supplied by Nielsen Digital Content Ratings shows that realestate.com.au gets 2.8 times the traffic compared to its nearest competitor Domain Holdings Australia Ltd (ASX: DHG). Visitors also spend 5 times more time on the app.
REA Group only charges a fraction of the total advertising budget for selling a property, when arguably it could command a much higher percentage of the advertising cost. That, and its market position, are why REA Group has been able to implement healthy prices regularly with little-to-no detrimental effect.
The price increases was a major cause of revenue growth of 15% in the recent half-year result despite a wobbly housing market and lower listing volumes. Of course, with properties taking longer to sell they end up being advertised on the REA portal for longer, leading to more advertising revenue.
Great economics with good re-investment plans
Excluding the impairment of the valuation of its Asian business which it overpaid for, REA Group grew EBITDA by 19% (click here to learn what EBITDA means), earnings per share (EPS) by 20% and free cash flow by 21% in the December 2018 interim result.
The profit growth was stronger than revenue growth largely thanks to an increase of the EBITDA margin from 60% to 62%. Increasing operating leverage is important for a business to deliver strong returns.
REA Group decided to only increase the dividend by 17% to 55 cents per share, retaining almost 60% of earnings for re-investment into the business. The re-investment has worked very well for REA Group since inception. The retained money generates a lot of cash for the company, using the regular profit figure the FY18 return on equity (ROE) was close to 30%.
REA Group has a promising Australian business, particularly add-on services like loans. But, the long term opportunity could be its overseas investment stakes in the US and Asia, which have much larger populations and property markets than Australia with its 25 million population.
Most of the businesses it is invested in are in the early stages and many are loss-making. Even so, REA Group said the Asian business grew revenue by 14% to $26 million and grew EBITDA by 27% to $5.7 million. In Malaysia it gets 1.5 times more than its nearest competitor, Singaporean site visits grew 57% year on year, PropTiger (the Indian investment) revenue grew 68% with traffic increasing by 41%.
In the US, realtor.com revenue grew by 11% to US$240 million and the average monthly unique audience grew 6% to 53 million.
Both of these regions could be as important for REA Group as Australia a decade from now.
Time to buy?
With the REA Group share price falling by 9% over the past six months, it is now valued at 26 times FY20 estimates according to CommSec. This seems like a reasonable price for a business with several growth avenues that’s currently going through ‘tougher’ times.
However, investors should keep an eye on the gap between REA Group and Domain. If its rival can close the traffic & time gap then REA Group may not be able to hike prices as quickly. But, duopolies have proven to be profitable in the past.
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