RTMVF - Rightmove: Great Business But Not A Bargain

2023-07-14 19:56:33 ET

Summary

• Rightmove, the UK's leading online property sales website, has a strong market position with a share of 88% among the top four property portals in 2021.
• Despite its dominant position and high profit margins, the company's growth opportunities are limited to the UK property market and potential competition from new market entrants.
• The company's shares are currently seen as fairly valued, with a P/E ratio of 22 and a dividend yield of 1.6%, and are recommended as a "hold".

U.K. property website Rightmove ( RTMVF ) has a lot going for it thanks to a leading position in the U.K. online property sales market. I think that is already reflected in its share price, however.

Half-year results are due out on 28 July.

Appealing Business Model

Rightmove essentially acts as a content aggregator between estate agents and buyers. Such a business model has network effects, similar to its U.K. motor equivalent Auto Trader (ATDRY).

In the long term I expect the U.K. property market to be buoyant. Demand is high and there is a mismatch between it and supply. Rightmove covers both sales and rentals.

Over the past decade or so, the number of property transactions (purchases) annually has ranged between 1.25m and 1.5m more or less. I expect this number to satay in flux due to factors like mortgage availability and property affordability. But ultimately the property sales market is not going away.

I don’t think Rightmove is a particularly special business, but it has managed to get into a strong position which gives it a competitive advantage thanks to network effects. It is the largest operator of its type and its market share of the top four property portals in 2021 was 88%.

The strength of this business model is on display in the company’s profit margins. Last year, revenues were £333m and post-tax profit was £196m. That is a post-tax profit margin of 59%, around the norm for the firm.

As its most recent full-year results show, the company is able to generate very sizeable profits.

Cash flows are a different story, with a net cash outflow last year (and indeed the prior year). However, the key driver for that was a share buyback programme. Last year, net cash from operating activities was £198m while (very neatly) the company spent £130m on buying back shares for cancellation and £68m on dividends. Given my view that the shares are not cheap, I do not think that is the best use of the company's surplus cash flows.

Risks

Although in broad terms I am upbeat about the long-term outlook for the U.K. property market, clearly if it deteriorates significantly that could hurt Rightmove’s profits. Recent news from homebuilders such as Barratt ([[BTDPF]], [[BTDPY]]) has suggested that storm clouds are gathering in the market, especially among those on the first rung of the property ladder.

I also see a risk that a new entrant to the market could east into Rightmove’s market share, especially if it is deep-pocketed enough essentially to buy shares. I do not see much that is solidly defensible about the Rightmove model. The core attraction (and it is really attractive) is its dominant market position. But that is not guaranteed to last, especially given how profitable the company has proven itself to be.

The balance sheet is appealing. The company is debt-free and highly cash generative.

Long-Term Growth Potential

The elements that make this an attractive space to be in also dictate limits to long-term growth. In the absence of a serious push into overseas markets, Rightmove’s growth opportunities are limited by what happens in the U.K. property market. It may ebb and flow but realistically it is not going to grow in dramatic, unforeseen ways.

The company has grown revenues at a CAGR of 9% over the past decade. The CAGR of post-tax profit has been 10%. Both of these growth rates are strong. However, given its strong market position at the moment, I see limited future growth opportunities for Rightmove unless it grows an ancillary business (e.g. conveyancing) or price gouges. It has been doing this: last year saw average revenue per advertiser rise 9%, for example. But I think there are limits to such an approach before pricing becomes an issue and opens the door for user defection to competitive websites.

The company’s ongoing sizeable share buyback programme arguably suggests it has run out of compelling ideas for how to deploy its capital on growth.

Valuing Rightmove Shares

Currently the shares have a dividend yield of 1.6%. The dividend is covered 2.8 times by earnings. Dividend growth has been solid but not really spectacular given how cash generative the company is: 31% from 2018 to 2022.

Currently the shares trade on a price-to-earnings ratio of 23. That compares favourably to other U.K.-based sales platform providers with market leadership, like car seller Auto Trader which has a P/E ratio of 26. Still, to me it does not look like good value from an objective perspective. While Rightmove benefits from its dominant market position, rival Purplebricks imploded this year. It was an estate agent rather than platform connecting estate agents to buyers, but is a reminder to investors about the need to ground valuations in reality in the U.K. property sales as elsewhere.

The shares are down 9% in the past year and are up only 4% over the past five years. That seems like a bit of a conundrum. Was the business potential priced into the shares five years ago and it has taken time for the reality to catch up with the share price? Possibly: earnings per share were 23.4p last year, up 31% from 17.8p in 2018. Or might it be that investors feel the shares are fairly valued for now?

I think there could be some support for the latter interpretation. Rightmove has a dominant market position, which gives it pricing power. But if it exploits that pricing power too much, it risks enabling young rivals to steal market share from it. After all, barriers to entry are pretty low (especially if an international rival already has the technology and experience): the main problem is that dislodging a leader in a market with strong network effect is notoriously difficult. That said, it is possible.

I think a P/E ratio of 22 is already high enough for a share that has gone nowhere in five years and yields under 2%, despite its undoubtedly attractive business model and substantial share buybacks (allowing for a 2018 stock split, in the past five years, over the past five years the issued share capital has shrunk by 10%).

On that basis, I see Rightmove as fairly valued for now and assign it a “hold” rating. I think it is an example of a great business not necessarily being a great investment opportunity, at least at its current share price.

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