The lower rates environment should continue fueling near-term demand for housing. Rates have dropped by ~0.4% to 0.6% since March.
As RedfinNow reopens with a limited budget, Redfin’s focus on its high-margin core real estate service business should drive margin expansion.
Management’s decisions to slow down RedfinNow and shift near-term focus to real estate services have been prudent.
We think that Redfin (RDFN) should continue to benefit from the increasing demand from homebuyers in the near term, fueled by the low rates environment. We expect such dynamics to draw more sellers to list their homes in the platform in Q2 and beyond. Furthermore, the lower TV advertising rates and the increase in viewership in recent times should also allow Redfin to drive higher ROIs on ad spend in its effort to stimulate both sides of the equation. Overall, performance has been solid since we initiated coverage on the stock last November with an overweight rating. We maintain our bullish view on the stock.
We expect the demand side to see a more pronounced rebound in Q2 as lower rates persist, drawing sellers to increase listings consequently. In Q1, Redfin saw a subsequent increase in demand for new homes from May onwards following a weaker outlook in March and April.
(Source: Mortgage Rates – Freddie Mac)
We think that the recent decline in mortgage rates within the same period was driving much of the demand. The 15-year mortgage rate, for instance, has dropped quite sharply from ~3% in mid-March to ~2.6% on June 17. With that in mind, we expect the uptrend in demand to continue as our initial concerns regarding the effectiveness of Redfin’s online video chat tour on driving success rates were brushed aside in Q1. In April, Redfin saw a 13% success rate from online tours, a significant hike from 2% in March. Overall, Redfin has so far seen demand returning to almost pre-COVID-19 level as of Q1.
The reopening of RedfinNow with a limited budget should shift much of the demand towards Concierge Service, which should see a favorable environment for the foreseeable future, potentially increasing revenue per transaction at a lower risk and lifting the margin. Despite the high growth, Redfin’s home-flipping business RedfinNow is still a loss-making and capital-intensive business. Though we believe in its potential, RedfinNow has an expected longer-term payoff than Redfin’s core real estate service business. Given the uncertainties, we think that the management has made a prudent decision to wind down RedfinNow temporarily, and then reopen it with a limited $20-million budget. Redfin has moved swiftly to reduce its $119 million obligations to $56 million from March to April, with a further reduction to $19 million in May.
(Source: company’s 10-Q)
Consequently, we expect Redfin to focus on Concierge Service, which is part of the real estate service business of Redfin that should see a favorable environment, driven by the stronger demand outlook and 5% YoY increase in median home prices. Redfin should then see higher margin in Q2 and beyond. In Q1, gross margin already significantly increased to 6.7% from merely 2.5% last year, driven by the ~14% gross margin in the real estate service segment. Moreover, the favorable TV advertising environment, in the meantime, will also allow Redfin to generate demands from both buyers and sellers at a more attractive ROI. Based on the management’s comment in Q1, advertising rates have been down 10% to 20%, while TV viewership has been up by 30% to 60%.
As CEO Glenn Kelman mentioned in Q1, gross margin will see limited upside, though expected to expand near term, considering that Redfin has expanded the range of customers its agents serve. At the lowest end of the range, Redfin’s agents now can sell a $150,000 home, compared to prior $200,000. Furthermore, without RedfinNow firing on all cylinders, Redfin will also now expect declining revenue growth in Q2 YoY.
We believe that Redfin remains well-positioned to continue gaining market share in the online real estate brokerage space in the long term. Given its exceptional growth in RedfinNow, its P/S has seen a premium in recent times as it traded at a previous YTD-high of 3.8x in February.
Most recently, it was also outperformed by the ~4x P/S seen in the second week of June, which we believe also reflects the increasing demand for housing. As such, this is still a fair price in our view. While the growth narrative has changed temporarily, the management has made a prudent decision to limit RedfinNow’s budget considering the uncertainties. RedfinNow, despite its high growth, also entails high risk. With that in mind, we also believe that profitability will drive Redfin’s P/S in the near term. We then expect Redfin to potentially trade higher than 4x P/S, as it continues focusing on its higher-margin core real estate service business, for the time being, regaining its profitability in the process.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha