REA Group wires future growth to global expansion: 1H net profit up 28%

Following the final rubber stamp for its $578 million takeover of listed portal small-cap business iProperty Group (ASX: IPP) earlier this week, News Corp majority-owned REA Group (ASX: REA) has given the market more good news with today's announced strong profit jump.

While far from unexpected, today's result saw the digital advertising company boost first-half profit by close to 30%.

The online property portal boosted net profit 28% to $121 million in the six months to December 31, up from $94.7 million in the previous corresponding period. This result excluded losses from associated businesses and profit from the sale of Squarefoot and marketable securities.

Including those in the result, net profit slipped 9.3% to $115.1 million, down from $126.9 million in the first half of 2014-15, while revenue was up 20% to $314.8 million.

The strong results increased returns to shareholders, with the board declaring an interim dividend of 36c per share fully franked, a 22% rise on the 2015 interim dividend.

The iProperty takeover is very much consistent with REA's strategy to invest in high growth regions. In addition to its Malaysia base, iProperty also owns portals which are market leaders in Malaysia, Thailand, Indonesia and the Hong Kong Region – plus a leading portal in Singapore.

Having been unable to repeat its local success in international markets, the iProperty takeover gives REA Group untapped access to a growing footprint within Asia's growth markets; where the transition from offline to online real estate advertising is still in its early phase.

Much of the future growth within the real estate market in Asia is expected to be driven by expanding populations and increasing GDP per capita, with the acceleration from offline to online advertising presenting an enormous opportunity for iProperty.

Having already owned 22.67% of iProperty Group, REA decided last November to take the company out at $4 a share, which compares favourably with upper valuations on the stock of $4.54.

iProperty suspended trading on 2 February, with REA Group expected to take control on 16 February.

In addition to being attracted to size and scale – which allows it to dominate its market position – the third source of its sustainable competitive advantage the market attributes to REA is what's called customer captivity – aka the difficulty with which customers can move to another supplier.

REA also benefits from the 'network effect' – which is not only hard to replicate, also adds to pricing power – where the greater the number of people joining, the more valuable and bigger it becomes in scale.

For example, home buyers gravitate towards because it has the most homes for sale, and as such tends to attract the largest audience of possible buyers. On average, consumers, deliver REA's Australian sites with over 42 million visits a month.

What REA hopes will continue to set it apart from its domestic competitors is its 'eyes-up' view of global markets, plus its ability to add more value to our customers and their vendors by connecting them to buyers and sellers around the world.

The challenge for REA now is proving it can create the same sort of sustainable competitive advantage it enjoys in Australia within its nascent south-east Asian markets, and further expansion into Europe and the US through its involvement in various online property portals.

Based on the quality of its earning and balance sheet, REA is truly an investment grade stock.

As well as having strong long-term cash flow relative to reported profits, it has a cash balance that exceeds debt, excellent return on equity (ROE) at 36.54% in 2015; and the stock is expected to deliver exceptional earnings per share (EPS) growth – with EPS of $1.34 in 2015 rising to $1.75 in 2016 and $2.11 in 2017 and $2.47 a year later.

With current debt outstanding on nil, and a net-debt to equity ratio of -14.15%, REA looks well positioned to complete the iProperty acquisition, and others are likely to follow.

Having posted cash collections of $32.3 million for the last three months of 2015 – an increase of 49.5% on the December 2014 quarter, the iProperty acquisition will contribute favourably to future earnings. iProperty also managed to achieve a strong net operating cash flow in its fourth consecutive operating cash flow positive period. 

Best estimates by REA's CEO Tracey Fellows put the potential revenue opportunity within Asia at around $1.3 billion. Equally encouraging, there's growing optimism within Malaysia that that the local property market will pick up from the second quarter, with sufficient funding likely to flow from population expansion and economic development.

Now focused on building a true multinational business, Fellows expects to leverage off the solid base of experience and knowledge built within local markets.

Despite the stock bouncing 38% higher since plunging to $37.78 in early June 2015, the stock still only trades on a 7% premium to its intrinsic value, which for a growth stock of this calibre is unusual.

Equally encouraging, IV is forecast to grow by around 20% over the next 12 months. Try to buy on further market corrections, a share price closer to $45 makes for more attractive buying.