So far this earnings season, despite strong earnings beats most of the stock reactions have been to the downside. Amid persistently high market multiples, Wall Street has expected nothing less than perfection.
One rare bright spot is Zillow (NASDAQ:Z), the real estate data site that has crumbled substantially since the housing market cooled off toward the back half of last year. Year to date, Zillow shares have soared more than 60%, buoyed recently by a strong Q2 earnings print as well.
The theme I echoed in my prior article on Zillow still rings true through Q2: despite a softer real estate industry, Zillow is doing much better than the brokers and agents who advertise on its platform. We also note that to counterbalance softer Premier Agent transactional trends, the company has seen material lifts in its Zillow Rentals segment.
I remain bullish on Zillow and think the current rally has legs. Long term, I view the bull case for Zillow as follows:
- Exit from iBuying shines the spotlight on margin-rich IMT segment. In 2022, Zillow generated a rich 27% adjusted EBITDA margin in its IMT segment (what is now loosely referred to as the “Residential” segment). That indicates a revenue stream that is nearly pure profit and very minimal overhead, and directly correlated with the uptick in real estate activity. To me, removing the distraction from iBuying and its horrendous quarterly losses will have the effect of expanding valuation multiples for Zillow’s profitable core business. Note that this 27% margin already captured the start of a housing recession; in the boom year of 2021, adjusted EBITDA margins in this segment were far higher at 46%.
- Across Zillow, Trulia, StreetEasy, and HotPads, virtually every American consumer thinking about buying or renting a home will come across one of the Zillow Group’s websites. Zillow has built an ecosystem rich with real estate data that has become the forefront of online real estate for users. Zillow traffic reached a record high of 10.5 billion visits (+3% y/y) in 2022.
- Zillow is a platform that can add a whole suite of additional monetizable services. With all this traffic, Zillow’s ability to generate tertiary revenue is broad. Currently, the majority of Zillow’s business comes from advertising fees paid by real estate agents, but the company is also expanding into distributing mortgage products as well. In the future, Zillow could offer a full suite of “after-market” home add-ons, including house insurance, moving services, furnishing/interior decoration services, and others.
- Capital-light internet business. Unlike other digital-age real estate competitors like Redfin (RDFN), Zillow runs its apps only – it doesn’t have to worry about compensating real estate agents or affiliates of its own.
- Substantial cash war chest. Zillow is well-capitalized to power through even an extended recession. On its most recent balance sheet, the company held $3.31 billion of cash and cash equivalents (for relative sizing, that’s nearly two years’ worth of revenue for the company) against $1.73 billion of debt.
Stay long here: with evidence that Zillow is slowly crawling out of the recent trough, it’s a great time to get into this stock and enjoy the upward ride.
Let’s now go through Zillow’s latest quarterly results in greater detail. The Q2 earnings summary is shown below:
Zillow’s overall revenue returned to slight 0.4% growth in Q2 to $506 million, well above Wall Street’s expectations of $473 million (which would have been a -6% y/y decline). Zillow also improved massively versus a -13% y/y revenue decline in Q1.
The improvement was driven largely by a sequential recovery in residential revenue – down -3% y/y, but up 5% sequentially to $380 million. Note that this outperforms a -22% decline in industry transaction levels by nineteen points – showcasing the strength of Zillow’s Premier Agent business in the wake of sharp industry headwinds.
Internally, the company had expected a -9% to -13% y/y decline in Residential revenue.
The company’s core growth strategy going forward is to increase the number of transactions completed with a Premier Agent. The company estimates that 25% of all U.S. homebuyers sought a Zillow Premier Agent over the past year, but that only 3% actually closed a transaction with one. The company is layering on additional product features, including financing options, virtual touring, and seller solutions in the hopes of increasing that transaction close rate to 6% by 2025.
Here is useful commentary from CEO Rich Barton’s prepared remarks on the Q2 earnings call, detailing how Zillow views current housing market trends and results in each segment:
As I think about the progress we’re making in the business, I’m pleased with how we have managed even as so much remains out of our control. Mortgage rates are staying higher for longer than previously expected and continued to be volatile, resulting in would be sellers hesitating to move due to their attractive legacy lower rate mortgages. This is having a more pronounced effect on sales volumes during the typically strong summer moving season.
Demand has held up better than supply, driving inventory to record lows and supporting prices despite affordability headwinds. With low existing home inventory, the new construction is a bright spot, adding new supply to help meet some of the demand and growing the overall housing stock. Our new construction marketplace experienced strong growth again in Q2.
Additionally, the rental market is adding record levels of new supply which has lowered occupancy rates and driven landlord demand for rental advertising contributing to 28% year-over-year growth in rentals revenue for us this quarter. The housing market outlook continues to be frustratingly foggy and we can only plan for it to take time to normalize. Volumes remained stubbornly low but we continue to have confidence that this is not some new normal and that we will get back to approximately 6 million units a year over time.”
As noted above, rental demand has been hot, increasing 28% y/y to $91 million in revenue (18% of the company total). The company attributed this increase to more aggressive marketing tactics from landlords, who are seeing a downward slide in occupancy rates.
Note as well that rental site traffic is up 15% sequentially to 31 million unique visitors in the second quarter.
From a profitability standpoint, Zillow’s adjusted EBITDA declined -23% y/y to $111 million, representing a 700bps contraction in adjusted EBITDA margins to 22%. This was driven largely by an increase in technology spend to support Zillow’s product roadmap (including touring and seller solutions features) that are intended to boost Zillow’s long-term transaction win rates.
Valuation and key takeaways
At current share prices near $56, Zillow trades at a market cap of $13.03 billion. After netting off the $3.31 billion of cash and cash equivalents against $1.73 billion of debt on Zillow’s most recent balance sheet, the company’s resulting enterprise value is $11.45 billion. Meanwhile, for the next fiscal year FY24, Wall Street analysts are expecting Zillow to generate $2.16 billion in revenue (+13% y/y) and $1.60 in pro forma EPS (+32%). And if we extrapolate Zillow’s first-half FY23 adjusted EBITDA margin of 22% out through FY24, its adjusted EBITDA would be roughly $475 million.
This puts Zillow’s valuation multiples at:
- 5.3x EV/FY24 revenue
- 24x EV/FY24 adjusted EBITDA
- 35x FY24 P/E
In my view, given Zillow’s recovering revenue trends, its dissolution of the low-margin Zillow Offers business, and its profitable bones that should deliver EBITDA/EPS margin gains over time, I think Zillow can flex up to 6.5x EV/FY24 revenue, implying a price target of $67 and ~19% upside from current levels.
I see Zillow’s continuous ability to beat housing-market trends as an encouraging signal of the company’s lasting brand power among real estate agents and homebuyers. Stay long here and ride the recent momentum.