Why the U.K. housing market?
The U.K. has one of the most stable and highly valued housing markets in the world. According to the Nationwide House Price Index, U.K. house prices increased 12.6% year over year. The average house price increased from 200,000 British pounds ($264,461) in 2015 to 275,000 pounds by the fourth quarter of 2021. Of course, there is a major difference between the northern and southern regions of the U.K., with London house prices substantially higher.
The U.K. currently has a housing shortage, with new housing starts of 216,000 houses in 2020-21 falling below the government's target of 300,000 new homes (data from the U.K. parliament). The country needs more affordable housing. As the demand is greater than the supply, I would expect prices to increase especially in the northern parts of the U.K.
Rightmove PLC (LSE:RMV, Financial) is the U.K.’s largest online real estate portal with a whopping 83% market share. Similar to Zillow Group Inc. (Z, Financial) in the U.S., Rightmove dominates the housing market in the U.K. and is poised to take advantage of the secular tailwinds. The company makes money via allowing estate agents to list properties on its website and is the go-to place to get the most property sales. For buyers, they have the most comprehensive list of properties and I personally find the platform easiest to use. This marketplace model gives the company strong network effects and an economic moat against new competitors.
As legendary billionaire real estate investor Sam Zell once said, “I like Monopolies. If not, I will take a duopoly.”
Economics 101 states competition drives profits toward zero for everyone. As Rightmove is most dominant, it is less affected by this factor.
Low capital expenditure
A couple of my favorite business models are those online and software companies as they don't have to double their fixed costs everytime they double the number of website visitors. In other words, they have high operating leverage, which means any extra revenue can flow more easily to bottom-line profits.
Rightmove is a strong case of this low capital expenditure and high operating leverage. In 2021, the company generated 150 million pounds in operating cash flow and spent just 2 million pounds on capital expenditure to achieve this. Over the past ﬁve years, the capex has accounted for around just 1.3% of the cash generated by its operations. This leaves a substantial wedge for growth, paying back debt and paying out dividends to shareholders (1.18% yield) currently.
The Zillow opportunity
Zillow is the largest online real estate portal in the U.S. Having previously done a deep dive into the business model, it’s clear that Rightmove can learn a lot from it in regard to what to do and what not to do.
First, the company has a vision called Zillow 2.0, creating a one-stop shop for property buyers and sellers. For example, they have a heap of features which I haven’t seen on Rightmove, such as the ability to book viewings direct from the platform (acquisition of showingtime) , 3-D virtual tours of a vast number of properties and even home loans. They are also planning to take advantage of the legal contracts and transaction market.
Conversely, when I compare the company to Rightmove, the service has barely changed in five years; they have done a lot on the agent side, but not much on the customer-facing platform. They have taken a low-risk, low-growth, dividend approach. This has worked fine, but I feel management is leaving a lot of cash on the table. Rightmove can also learn what not to do from Zillow, such as the house-flipping business, which has high capital expenditure and ended in disaster.
Revenue grew 46% to 305 million pounds, up from an uncharacteristically low 206 million pounds in 2020 but only up 6% from 2019 levels.
The company aslo saw record agency average revenue per account growth of 120 pounds, a 12% increase from 2019 to 1,155 pounds.
It has a high operating margin of 74%, with an operating profit of 226 million pounds.
Closing cash of 48 milion pounds (as of Dec. 31, 2020: 96.7 million pounds)
Is the stock overvalued?
I have plugged the latest financials into my valuation model, which uses the discounted cash flow method. I have estimated revenue growth to continue at between 6% and 7% and margins to increase slightly, from an increase in add-on services.
From this valuation, I get a fair value of 5 pounds per share. The stock is currently trading at 6.6 pounds per share and, therefore, is approximately 30% overvalued.
(Ignore the dollar sign in the model; the currency is British pounds.)
The stock is currently trading at a price-earnings ratio of 27, which is high for the U.K. market (FTSE 100 has an average price-earnings ratio of 15) and a price-sales ratio of 17.
The company previously faced backlash from realtors in the U.K., so Rightmove had to offer discounts to keep them on board. This could suppress the company's margins in the future. Similarly, if a competitor drops prices, agents may migrate.
Then there is a suspected rise in interest rates to curb the high inflation, which could increase the mortgage costs and may slow down the U.K. property market. In addition, a rise in interest rates will increase the discount rate and suppress the company's multiple.
The company has an incredible business model and dominant market share, but the valuation is still a little spicy even after the recent pullback. However, as I already own shares, I will be holding due to the dominant market position and potential for upsell services in the real estate market.