After reporting its first quarter 2024 earnings results, arguably the most important as they set the tone for the rest of the year, shares of Zillow Group Inc. NASDAQ: Z are trading lower by as much as 12% in the after-market hours following the announcement. While markets have enough evidence to dump the stock, they could ignore the big picture.
The reason behind the sell-off comes mainly from management’s negative—though responsible—outlook for the next quarter and potentially the rest of the year. Driven by currently deteriorating real estate sector dynamics, management chose to keep investors in the loop rather than sell empty promises.
As the Vanguard Real Estate ETF NYSEARCA: VNQ struggles to catch up to the broader S&P 500 after underperforming by as much as 25% over the past 12 months, a potential bottoming could be coming soon to help Zillow’s main businesses. Even if the bottom isn’t here yet, management thought of other ways to still beat expectations.
Why the Negative Outlook?
Has the Federal Reserve (the Fed) made up its mind? The path of interest rates for 2024 is still undefined. As mortgages now hover near 7.6%, and home prices (though recently declining) still stand 32% above their pre-pandemic levels, real estate agents now have a lot of time in their hands.
According to the Intercontinental Exchange Inc. NYSE: ICE, most mortgages today carry an average interest rate of 3.25%. Because of this, most homeowners aren’t looking to get rid of their appreciated homes at dirt-cheap rates, and would-be buyers aren’t that keen to finance a new home at cyclical highs (both in price and financing rates).
Because of this current environment, Zillow’s shareholder letter suggests a disappointing next quarter. More than that, recent National Association of Realtors (NAR) changes to agent commissions have made it harder for Zillow to see volumes on its platform, or so markets think.
Top Quality, Top Earnings
Management points to two drivers that can likely beat around the bearish bush within that same letter. First, a decline in transaction volume due to lower potential commissions is only a cleanse.
According to management, 20% of real estate agents handle 80% of residential transactions. Zillow works with “four in five” out of these top-tier agents.
What this means is that even if some of the nonperforming agents do fall off the platform, it only gives Zillow a stronger path to better customer experience and service through top-notch agents.
Because of this talent retention, analysts at J.P. Morgan Chase & Co. NYSE: JPM still see a price target of $65 a share for Zillow. The stock would need to rally by 55% from today’s prices to prove these valuations right.
Those at Jefferies Financial Group Inc. NYSE: JEF see an even richer valuation of $75 a share, reflecting a 79% upside from today. It should be no surprise to see these analysts' projections for 43.1% earnings per share (EPS) growth this year, above the real estate operations industry's 22.7% expected growth.
Investors should also remember that, despite the lower guidance, Zillow still beat analyst expectations on revenue and earnings before interest, tax, depreciation, and amortization (EBITDA).
Never Mind the Dip
Realizing that sitting around to wait for a revival in residential transactions could prove futile, Zillow decided to move into the next best thing: the rental market. If people don’t buy expensive homes and mortgages, they will be forced to rent.
According to management’s presentation on rentals, Zillow is tapping into a total addressable market worth $25 billion. Zillow’s share is projected at 1% ($250 million in additional revenue).
Investors may be thinking, what will Zillow do as the new guy on the block for rentals compared to other platforms like Apartments.com? Beat them, that’s what.
Rentals search traffic goes to Zillow, as it surpassed Apartments.com in 2022 and currently stands at nearly 30 million average monthly visitors, versus Apartments.com’s 22 million roughly.
To quantify this positioning further, investors can check out Zillow’s press release, which shows a 31% jump in annual rentals revenue, reaching $97 million. Residential transactions revenue rose only 9%, meaning that Zillow’s new dual business could help the stock cushion a slump in real estate.
To top it all off, the stock (after its earnings selloff) now trades at 68% of its 52-week high, underperforming the real estate ETF by as much as 32% in the past quarter.
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