Zillow Group: Multiple Growth Catalysts, But Slowdown In Residential Is A Concern

seekingalpha05-18

Zillow Group's 1Q24 earnings beat estimates, with revenue growing 13% to $529 million.The company has three major growth catalysts: agent solutions, expansion into new markets, and a strong Rentals ...

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I still think ZG has a buy rating, as there are visible growth catalysts that should continue to drive high-teen growth ahead. My concern is the potential slowdown in Residential segment, which is making me believe that achieving $5 billion in sales in FY25 is increasingly unlikely. In my revised model, using my high-teens revenue growth assumption, ZG should be able to hit ~$5 billion in revenue by FY29, and at a 45% EBITDA margin and 12x forward EBITDA, even after discounting by 12% per year, still translates to attractive upside. Investment thesis On 1 May 2024, ZG released its 1Q24 earnings, which were solid. Revenue grew 13% to $529 million, with EBITDA coming in at $125 million, both beating consensus estimates. Revenue of $529 million also came in above management’s own guidance of $495-$510 million. By segment, Residential revenue saw $393 million, beating guidance of $365 to $375 million; Rentals revenue saw $97 million; Mortgage revenue saw $31 million; and Other revenue saw $8 million. There are three major growth catalysts that should continue to drive very healthy growth rates for ZG in the near-to-medium term. Firstly, it is the launch of several agent solutions. For example, ZG should be able to identify high-intent buyers with the launch of Touring, which has yielded excellent results thus far: Connecticut has a 20% higher conversion rate than the rest of the country. Based on management's plans to launch Real Time Touring in 124 markets by May and for it to contribute approximately 20% of total connections by year's end, I expect an improvement in conversion rates throughout the upcoming quarters, which drives revenue growth. The other product highlight is its seller solution, Listing Showcase. The adoption and results are tracking really well on this front too, where listings are being closed at a higher price (2% more than non-listing Showcase); agents are getting a 20% higher probability of getting an accepted offer within 2 weeks; and lastly, agents are winning ~20% more listings. I think these results should encourage sellers to increase adoption. By management’s math, assuming a target for 5–10% listing coverage for Listing Showcase, it represents a $150–$300 million annual revenue opportunity, which is a 15% uplift at the high end vs. FY23 revenue. The second growth catalyst is ZM expansion into 40 Enhanced Markets. My belief is that ZG's Mortgage revenue will grow as the number of enhanced markets it serves increases throughout the year, thanks to the Premier Agent networks' ability to increase the attachment rate. Since home loan products are typically associated with transactions in enhanced markets, penetrating these markets also brings the advantage of higher revenue per transaction. Specifically, management saw double-digit adoption rates of home loan products across its Enhanced Markets. Currently, the company operates in 19 Enhanced Markets. If ZG can reach its goal of 40 Enhanced Markets by the end of FY24, it will more than double its addressable market, creating a massive opportunity for growth. The last growth catalyst is Rentals. ZG continues to execute and capture demand in this area, where it delivered its seventh consecutive quarter of growth in the Rentals segment. As of March 2024, ZG has around 1.8 million rental listings, which represents 50% of total industry rental listings (according to 1Q24 call). Given that ZG has a lion’s share of rental listings, it is sure to continue benefiting from the housing supply situation in the US (I have spoken about this in my previous post). In a recent survey, 77% of US residents prefer to rent instead of buying a home, and I think this speaks really well of the demand strength for ZG in the near-to-medium term. Valuation   Own calculation Although I mentioned multiple growth catalysts, and I am definitely positive about them, the softening outlook for residential growth (refer to the risk section below) made me think that it is increasingly unlikely that ZG can hit its target for $5 billion in revenue and adj EBITDA in FY25. Using 1Q24 growth (13%) as a baseline, I believe a high teen growth rate is still possible given the visible growth catalyst (which could have been higher, but I think the softening Residential revenue may subdue the growth strength). Assuming 17% growth, it would take ZG four more years than expected to hit the ~$5 billion target. At a 45% ETBIDA margin (long-term guidance), this translates to ~$2.25 billion in EBITDA. Attaching the SPX average forward EBITDA multiple of 12x to $2.25 billion translates to a FY28 share price of $117. Using my own required rate of return of 12%, I think ZG is still worth ~$75 today. Risk My biggest concern with ZG is the potential weakening of the Residential segment. Management guided to 2Q24 Residential revenue of $372 to $382 million, implying a 1% decline at the midpoint. Since ZG is overly indexed to first-time home buyer demand, whose performance has been weak so far (MBA’s FHA Mortgage Purchase Application Index has underperformed the overall mortgage buyer index by 800 bps in recent weeks, according to management during the call), this is not a good sign for near-term growth. Moreover, mortgage rates continue to increase, which is a big headwind for homebuyers. If rates continue to stay high, ZG is at risk of seeing very poor performance in the Residential segment, which could drag down overall growth. Conclusion  In conclusion, my rating for ZG remains a buy despite a potential slowdown in the Residential segment. Multiple growth catalysts, including agent solutions, expansion into new markets, and a strong Rentals segment position ZG for continued high-teen revenue growth. While the $5 billion revenue target in FY25 may be out of reach, even if it achieves the target in FY29 (based on my high-teens growth expectations) the upside is still attractive.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.0","shortVersion":"4.24.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2436590735"}