COMP - Compass Continues Cost-Cutting In Challenging Environment

2023-04-17 14:20:08 ET

Summary

• Compass went public in April 2021, selling its shares for $18.00 each.
• The firm provides technology-enabled brokerage services in various major markets in the United States.
• The residential real estate industry has endured a sharp drop in volume as interest rates have increased sharply in the past year.
• Compass has been slashing costs and will continue to make cuts.
• Given uncertain macroeconomic conditions and likely 'higher for longer' interest rates, I'm on Hold for COMP in the near term.

A Quick Take On Compass

Compass ( COMP ) went public in April 2021, raising approximately $450 million in gross proceeds in an IPO that was priced at $18.00 per share.

The firm provides an online website and agent network for facilitating residential real estate transactions in the United States.

Given increasingly uncertain macroeconomic conditions and the firm's need to continue cutting costs, I'm Neutral (Hold) for COMP in the near term.

Compass Overview

New York, NY-based Compass was founded to develop an integrated platform of a suite of cloud-delivered software capabilities to residential real estate agents.

Management is headed by Founder, Chairman and CEO, Robert Reffkin, who was previously at Goldman Sachs as Chief of Staff to the President and Chief Operating Officer at Goldman.

The company's primary offerings include:

• Listing services

• Virtual tour hosting

• Home valuation analysis

• Prospecting recommendations

• Listing analytics

• Transaction closing management

• Compass Concierge

Compass' Market & Competition

According to a 2022 market research report by Research and Markets, the global market for real estate sales and brokerage services in the U.S. was an estimated $1.34 trillion in 2022 and is forecast to reach $1.9 trillion by 2026.

This represents a potential growth of 9.2% from 2022 to 2026.

The main drivers for this expected growth are continued strong demand for real estate property as a hedge against inflation, a store of value and for financial diversification purposes.

Major competitive or other industry participants include:

• Zillow

• Redfin

• Trulia

• LoopNet

• Realtor.com

• Other local MLS services

Compass' Recent Financial Trends

• Total revenue by quarter has begun trending lower:

• Gross profit margin by quarter has also been dropping recently:

• Selling, G&A expenses as a percentage of total revenue by quarter have been in a rising trend, a negative development:

• Operating income by quarter has been worsening further into negative territory:

• Earnings per share (Diluted) have remained heavily negative, as the chart shows here:

(All data in the above charts is GAAP)

In the past 12 months, COMP's stock price has dropped 47.7%, as the chart indicates below:

For the balance sheet, the firm finished 2022 with cash and equivalents of $361.9 million and short-term borrowings of $181.9 million.

Over the trailing twelve months, free cash used was a whopping $361.8 million, of which capital expenditures accounted for $70.1 million. The company paid a very high $234.5 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Compass

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

Future Prospects For Compass

In its last earnings call (Source - Seeking Alpha), covering Q4 2022's results, management noted that 2022 saw 'one of the sharpest declines in transaction volume in decades…' declining approximately 18% during the year.

In response, the firm made non-GAAP cost cuts of $338 million, and leadership has plans to further reduce its operating cost structure.

However, sales 'inventory remains low, and mortgage rates have continued to rise', as the chart below shows 30-year fixed mortgage rates over the past 12-month period:

Looking ahead, management is continuing to reduce new agent incentives and has halted new M&A activity as it plans to focus on going more deeply into existing territories rather than broadening its coverage footprint.

Management's priorities for 2023 include integrating title and escrow functions into its technology platform, which is already beta testing in Southern California and continuing to attract top performers despite an industry agent contraction.

The company's financial position is relatively strong, with significant liquidity; however, management will need to reduce its cash burn to increase its runway.

The primary risk to the company's outlook is the Federal Reserve's 'higher for longer' assumption, which may keep interest rates at elevated levels for 2023 and perhaps beyond.

A potential upside catalyst to the stock could include a pause in interest rate hikes, leading to potential downward pressure on mortgage rates.

Also, the firm is entering the seasonal sweet spot of home-buying activity in the second and third quarters of the year, which may result in upward stock price pressure.

However, a wild card is the recent banking crisis with SVB, Signature, and Credit Suisse, which appears to already be causing small and regional banks to reduce their lending activity.

Noted industry observers and investors such as Warren Buffett have indicated that bank failures may not be over ( Video here - Source, CNBC).

While 2023 existing home sales have increased by about 10% by the end of the first quarter, which may be due to seasonal factors, I'm still cautious about credit availability to consumers in the wake of the bank crisis of March 2023.

Given increasingly uncertain macroeconomic conditions and the firm's need to continue cutting costs, I'm on Hold for COMP in the near term.

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