COMP - Compass: Assessing The Road Ahead

2023-10-16 04:59:21 ET

Summary

• Compass has a positive competitive standing and strong brand reputation, but there are risks to the agent commission model and uncertainty in expanding related services.
• Q2 earnings saw a decline, and the company expects a decline in market volumes for the fiscal year.
• COMP is focused on managing operating expenses and investing in research and development, but the stock may experience a negative reaction if earnings fall short of expectations.

Thesis

I have a positive outlook on Compass, Inc.'s ( COMP ) competitive standing and am confident that its robust brand reputation and top-tier technology resources will allow the company to recruit highly efficient agents, ultimately gaining market share in the long run. However, it's important to note that there is a growing risk to the current agent commission model over the next decade, and the ability for related services to expand successfully and grow remains uncertain. Moreover, there is a potential for transaction growth to slow down if interest rates rise or if home sales stabilize. Hence, I remain cautious at this stage and assign a hold rating to the stock.

Q2 Review and Outlook

COMP's second-quarter revenues saw a steep 26% YoY decline, with EBITDA at $30 million, landing at the lower end of the second-quarter guidance range of $30-50 million and below the consensus estimate. The primary focus for the company is to streamline its operating cost structure, given the challenges in the existing home market, especially with the recent increase in mortgage rates surpassing 7%. COMP has acknowledged the possibility of a decline in market volumes for the fiscal year, likely towards the lower end of the previously expected range of 15-20%.

In the short term, earnings are expected to remain under pressure, given the limited availability of existing home inventory. However, COMP is making efforts to manage its operating expenses and continue investing in research and development. In the third quarter, the company anticipates revenues between $1.3-1.4 billion and adjusted EBITDA in the range of $15-35 million. While COMP still expects to achieve positive free cash flow for the full year, it is no longer committed to a positive outcome in the fourth quarter, a quarterly result that is not considered critically important.

The slowdown in market volumes due to rising mortgage rates is the key change in the earnings outlook. COMP remains focused on bringing its annualized operating expenses down to $900 million, and it's on track to achieve this target by the fourth quarter. Despite this, the stock may experience a slight negative reaction, especially if second and third-quarter EBITDA falls short of consensus expectations. On a positive note, COMP is experiencing reduced competitive pressure for top agents, resulting in lower commission splits year-over-year. Additionally, the company is leveraging its strong technological capabilities to recruit and retain agents, even as competitors may be scaling back in this challenging market environment.

Tech-Enabled Platform for the Real Estate Market

COMP has adopted a unique strategy in the residential real estate industry, which has contributed to the rapid expansion of its agent network. Unlike many other real estate tech firms that aim to replace agents entirely, COMP has focused on enhancing agent efficiency. This approach is evident in their impressive agent growth. Although COMP has made significant strides, I believe the company is still in the early stages of its growth story, given the immense size of the US residential real estate market. There are over 2 million active real estate agents in the US, suggesting COMP's market penetration is minimal, with approximately 28,000 agents, which is about 1.4% penetration in terms of agent numbers. I anticipate COMP to increase its market share by sales volume going forward. With the added benefit of improved agent productivity and high retention rates, I expect COMP to substantially increase its agent base in the coming years.

Valuation

COMP is currently trading at a forward EV/revenue multiple of 0.17 times the forward estimate. This places it at a discount compared to companies primarily focused on residential brokerage like [[RMAX]] and at a significant discount when compared to real estate technology and software firms such as [[APPF]] and [[CSGP]]. I believe the depressed multiple represents the several risks currently faced by the company. A potential slowdown in transaction growth is probable if interest rates increase or if the current level of home sales stabilizes. Moreover, COMP's capacity to expand into related markets is uncertain, and regulatory obstacles may hinder its entry into certain sectors. I hold a positive view of COMP's competitive standing and anticipate that its robust brand recognition and top-notch technological resources will empower it to attract the most effective agents, ultimately allowing it to gain a larger market share in the long term. However, it's essential to acknowledge that the existing agent commission model faces increasing risks in the coming decade, and it remains uncertain whether COMP's expansion into related services will successfully grow and scale. Therefore, I currently stay cautious and assign a hold rating to the stock.

Investment Risks

Residential real estate commissions are facing increasing pressure and are expected to experience a significant decline over the next decade, as readily available information on residential real estate and its pricing empowers consumers. Moreover, real estate agents are becoming accustomed to higher commission splits, whereas Compass's long-term strategy assumes lower commission splits for agents. Furthermore, Compass aims to diversify its revenue streams by expanding into related sectors like title and escrow services and mortgage origination, but this expansion could be hindered by federal and state regulations.

Conclusion

COMP operates a tech-enabled platform in the residential real estate industry with a unique strategy focused on improving agent efficiency. The company has seen rapid growth in its agent network but is still in the early stages of expansion. The company's depressed valuation reflects the risks the company faces, including the potential for a slowdown in transaction growth due to rising interest rates or stabilized home sales. Hence, I remain cautious on the stock and assign a hold rating to the company.

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