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Glass Half Full or Empty?

The market’s reaction to the Carsales.com and REA Group full year profit results was perverse considering both companies delivered on the high growth guidance. The initial negative price reaction suggested investors were no longer believers in the earnings models and that each stock was fully priced.

Having spent time with the management of each company this week, we can confidently say that the market is underestimating the future potential of each business.

REA Group’s operating earnings of $225.1m includes the initial sprouts of its new and improved earnings model that aims to clip the ticket on vendors rather than real estate agents.

The premium and depth products revenue and earnings growth demonstrated in the numbers clearly showed the company is at the early stages of its strategy to rebalance how it charges for real estate advertising based around the post code of a property and its ability to afford an appropriate marketing spend.

By placing less of the marketing burden on agents through lower subscription fees and more of the expenditure on vendors in proportion to their property value, REA will substantially lift the addressable market value.

It was interesting to see the comparison with Fairfax Media’s Domain business which reported operating earnings of $57.6m which includes both print and digital earnings.

REA’s big advantage over Domain is its reach and penetration which shows REA has 3.1 times the number of visitors to its websites than Domain and the time spent on its websites is 4.7 times as much.

REA will nudge $300m in EBITDA in FY15 which implies investors are paying a multiple of around 19x at the current share price. That is undemanding for a business that has increased operating earnings by 30% pa for the last 6 years.

Carsales.com experienced a similar moment of weirdness following the release of its annual result where the share price plummeted and has since been restored to a more sensible path.

Like REA, CRZ still has oodles of growth available beyond its core competency of providing leads for new car dealers and a thriving market for the purchase and sale of cars, bikes, caravans and so on.

Car manufacturers and dealers have played a silly game of withdrawing inventory from Carsales’s website mistakenly believing it was hurting their ability to sell vehicles. They have subsequently found themselves holding too much inventory and are rediscovering the benefits of the conduit that Carsales provides to facilitating leads and sales.

Carsales also has more growth from interesting developments such as in tyres. Australia’s $4bn tyre market is ripe for a shake-up by providing customers with better transparency and comparison of brands and prices via the internet.

The addition of businesses like Stratton Finance can also give CRZ a nice boost but investors should understand this business is lower margin than the core business. Even so, it fills a sensible and attractive gap in the portfolio and will be a solid contributor to earnings in years to come.

CRZ has also lobbed some money into a few international ventures that will take time to bear fruit. Brazil and Korea are very different markets to Australia but both are larger and very receptive to adopting CRZ’s excellent technology.

CRZ will likely deliver operating earnings around $160m in FY15 putting it on a multiple of about 17 times. Once again, that seems more than reasonable for a high growth business with the same 30% compound annual growth rate of 30% as REA.

Glass half full, we say.

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