2023-08-09 09:51:25 ET
Summary
- A year ago, I rated Anywhere Real Estate as a sell due to its valuation and its poor competitive position in the real estate brokerage industry.
- My thoughts on its competitive position have not changed, but the stock’s rise after Q2 earnings provides another opportunity to sell or short the stock.
- I estimate the stock could decline by 10-30% in the next 12-18 months as the multiple compresses to its long-term average, given my assumptions of poor upcoming financial results.
- Longer term, Anywhere’s debt will continue to cause problems as I believe the housing market won’t improve as quickly as management thinks. This caused operating income to remain low.
A year ago I assigned Anywhere Real Estate Inc. (HOUS) a sell rating due to my views that a successful turnaround and deleveraging efforts are unlikely to be successful. Anywhere's stock is down 25% since then but I believe the recent rise after Q2 earnings provides another attractive entry point for a short position.
I don't think Q2 results provided any reason for investors to be more confident about the business going forward as sales and transaction volume fell 20%+, and management continued to boast about extreme cost cutting measures that were far ahead of schedule. In a highly competitive industry like the real estate brokerage industry that they operate in, this is not something that instills confidence in the future of the business. I will provide more details later in this report, but the true industry leaders are maintaining investment levels to secure a competitive position in the industry.
Besides the cost cutting measures, management also boasted of AI and machine learning capabilities in the prepared remarks portion of the Q2 earnings call. In general, I believe the language was quite vague and did not provide any true insights into how these capabilities would help the business going forward.
In general, the past year of results and commentary from Anywhere Real Estate have done nothing to change my thoughts on the long term prospects of the business and the recent rise of its stock creates an attractive risk/reward for a short position. I am basing this off of my estimate that Anywhere's EV is currently 9x my optimistic 2024 EBITDA estimate.
While this doesn't seem unreasonable, this is a very optimistic scenario and I believe that there is a good chance that Anywhere misses these numbers given my views of the economy and the housing market. This provides plenty of time for multiple compression and will also provide more time for their debt to eat away at profits, which will further create the need for Anywhere to starve itself of growth and maintenance capex. In turn, this will further hinder Anywhere's ability to grow and gain share in the future considering how competitive the real estate brokerage market is.
Q2 2023 Business Updates
Anywhere reported Q2 earnings on July 25th and missed earnings expectations despite beating revenue expectations. The large year over year decline in revenue and earnings was not surprising as housing market transactions remain low due to high interest rates.
Q2 Results from Operations (Anywhere Real Estate Q2 Press Release)
Anywhere's story remains largely the same. Management is emphasizing its franchise business and luxury business, both of which are higher margin, and is boasting about its cost cutting measures and AI capabilities.
While management maintains a positive tone, I still see Anywhere as a declining business in a highly competitive and changing industry. I would be more optimistic about its chances of a successful turnaround if it weren't for the fact that its debt, which is balanced mainly by intangible assets, is making it necessary to cut costs and starve the business of necessary growth and maintenance capital expenditures in order to keep up with interest payments.
Regarding interest payments, Anywhere announced a debt exchange offer at the same time it released Q2 earnings. In this transaction, Anywhere offered to exchange up to $527 million of its 5.75% 2029 Senior Notes due 2029 and its 5.25% 2030 Senior Notes due 2030 for up to $429 million of new 7.00% Second Lien Senior Secured Notes due 2030. In addition to providing flexibility this transaction will marginally increase interest payments through 2030. This exchange doesn't change the bigger picture of its debt issue but it does push out repayment of its principle which may provide some flexibility over the next few years.
Regarding its cost cutting measures, I don't think Anywhere will be able to maintain market share while cutting capital expenditures and reducing its employee headcount so drastically. The real estate brokerage industry is highly competitive as real estate agents don't have loyalty to a brand, they simply go where they will be able to make the most money. This leads to high churn and constant pressure to reduce commission splits.
I've written about eXp World Holdings, Inc. (EXPI) in the past and it is currently one of the fastest growing and largest real estate brokerages in the world. They were able to grow by offering agents the highest value proposition which included revenue sharing based on agent referrals, and low commission splits. eXp's North American Realty business is also relatively profitable and it generates significant cash flow due to its high variable costs and a large amount of expenses paid in stock. This provides flexibility to further invest in the business even in a downturn to create the platform that provides the most value for agents and allows agents to make the most money.
Even with their already low prices for agents, eXp recently lowered prices again in the form of reducing revenue share. When one of the largest and more profitable brokerage continues to lower prices in a down market, a brokerage like Anywhere will struggle not only because they can't lower prices due to the high interest expense, but because they are also cutting costs and growth capital expenditures which reduces their value proposition and only leads to more agent churn.
Much of the optimism from Anywhere's management comes from the idea that once the housing market turns when rates are lowered in late 2023 and 2024, Anywhere will become more profitable and will be able to deleverage. I think management is getting ahead of itself. All signs point to a strong economy that is resilient to higher interest rates. This will cause the federal reserve to maintain interest rates at their current levels for a longer time than many are expecting. For businesses like Anywhere that benefit from real estate transactions, this will continue cause issues.
In fact, since the Q2 earnings call mortgage rates have increased substantially and mortgage applications have decreased.
Early August 2023 Mortgage Rate (Bill McBride (@calculatedrisk) Twitter)
Additionally, all signs also point to economic growth later in the year. The Atlanta Fed's GDPNow real GDP estimate for 2023 was recently updated to 3.5% growth.
Atlanta Fed Real GDP Estimate (Atlanta Fed)
All of these factors should lead to more struggles for Anywhere's operations and I believe this will cause Anywhere to miss earnings expectations in the second half of 2023 and into 2024.
Valuation
Anywhere is currently trading at its highest multiple in some time due to a combination of lower earnings and a higher stock price. Its EV is currently valued at 12x its trailing twelve months EBITDA despite last being at this valuation in 2014 when the business generated $716 million in EBITDA and had an interest expense of $267 million. In the most recent trailing twelve months, Anywhere generated $262 million in EBITDA and had an interest expense of $144 million. In 2014, the business was also growing its topline and had an operating margin of 10% compared to its currently declining revenue and 1% operating margin over the past twelve months. All of this is to say that Anywhere was in a much better spot the last time it was trading at 12x EBITDA.
What this tells us is that the market is expecting things to get better for Anywhere because it would surely not trade at this valuation if the market expected financial results to remain the same going forward. But I believe the market is getting ahead of itself. Even in an optimistic scenario, Anywhere is trading at a forward valuation in line with its average. This provides investors with little protection against multiple compression. In my bear case estimates, Anywhere is trading at a premium valuation.
In my bull case, I assume Anywhere's revenue will decline by 16% in 2023, and rise 10% in 2024 to reach $6.38 billion. This is above what analysts are expecting. I am assuming Anywhere has an operating margin of 4% in 2024, and D&A equal to 3% of total assets which I assume are $6.4 billion. This would lead to EBITDA of $382 million in 2024, or 11x the current EV. This is above the average EV/EBITDA ratio of the past 10 years and given the shaky future prospects of the business, I believe the multiple would compress to its 10 year average of 10.3x which would put the EV at $3.9 billion, or 8% below its current EV.
In my bear case, I assume Anywhere's revenue also declines by 16% in 2023, but rises 2.5% in 2024. I am assuming Anywhere will have an operating margin of 3% and D&A will also equal 3% of total assets of $6.4 billion. This would lead to EBITDA of $370 million in 2024, or 11.5x the current EV. This is higher than the average EV/EBITDA ratio of the past 10 years. Due to this poor performance I would assume the multiple would compress to below its 10 year average to 8, which would lead to an EV of $2.96 billion and a decline of 30%.
With these two scenarios I see a decline of 8% to 30% in Anywhere's EV over the next 12-18 months. Longer term, I think Anywhere's poor competitive position will lead to a loss of market share and stagnant or declining revenue over time. This coupled with interest payments that will consumer most of its operating income, makes Anywhere's long term future very murky. They will be able to refinance to meet their upcoming maturities, but longer term it's difficult to know if they will be able to meet obligations as the business loses share.
I rate the stock as a sell, and believe it is a compelling short at its current valuation as I believe there is short term downside between 10% and 30% over the next year, and long term downside as the business declines and its debt becomes more of an issue.
Risks
The current economic environment is somewhat unique for the real estate market. Homebuilders are enjoying an optimal scenario as they are able to provide incremental supply to a market where new listings are low. This supply is being bought up quickly.
On the other hand, businesses like Anywhere that benefit from transactions are suffering as homeowners locked into low rate mortgages are not selling and buyers are having difficulty affording homes due to high mortgage rates.
I believe that, ironically, a weak economy could benefit Anywhere. A recession would lead to not only forced selling that would produce more transactions, it would lead to lower rates which would encourage buyers and lighten the burden of Anywhere's debt. As transactions accelerate and interest expenses drop, Anywhere's earnings would rise and the market may assign the stock a higher multiple. This would not change my view of Anywhere's competitive position in the industry, but it would hurt the near term short thesis. Investors should consider covering their short position in this situation.
Anywhere does not have much of a chance for a short squeeze as the shares sold short as a percentage of the float is relatively low at around 5%. Long term puts may be more attractive for more those that wish to avoid being on the wrong side of a squeeze, but there is low option volume Anywhere's stock. For this reason, it would be best for risk averse investors to avoid betting against Anywhere.
Final Thoughts
Anywhere's story hasn't changed in the past year and my thoughts on the long term prospects of the business haven't changed either. I believe the company will continue to perform poorly as it aggressively cuts costs and starves itself of growth and maintenance capital expenditures in order to keep up with interest payments. Anywhere is hurting its position in the very competitive real estate brokerage industry by doing this and won't keep up with the constant innovations that will change the industry.
In the short term, Anywhere's valuation is stretched as the market has gotten ahead of the housing market turnaround story. I believe this will lead to a 10-30% decline in the stock over the next 12-18 months. Coupled with what I believe will be a longer term decline beyond the next year, Anywhere's stock looks like a compelling short.
For further details see:
Anywhere Real Estate: Overvalued And In A Poor Competitive Position