2023-05-30 05:06:06 ET
Summary
- Zillow continues to demonstrate strong performance and execution, tracking toward its long-term revenue and margin targets, despite a challenging macro environment.
- The company has outperformed in its Premier Agent segment, gaining market share and showcasing the effectiveness of its innovative offerings.
- ZG's ability to consistently innovate and drive new products, coupled with its investment in AI and data utilization, positions the company favorably for future growth.
Overview
This is a follow-up to my buy rating thesis on Zillow Group ( ZG ) (Z). Just to give an update, the stock has continued to track my long-term target price of $90 set out in my previous post. As ZG shows it is on track to meet its FY25 target of $5 billion in revenue and 45% EBITDA margin, I think there is still attractive upside from here. My confidence in this is further boosted by the strong 1Q results across the boards, with both revenue ($469 million vs consensus $426 million) and adj. EBITDA ($104 million vs consensus $61 million) posting a much better-than-expected results against its own guidance. Following a successful first quarter, management has provided an optimistic outlook for the second quarter, despite some pressure on EBITDA that, in my opinion, is merely a function of timing (expenses pulled forward from 2H23). So far, ZG has presented a very upbeat story, with solid execution and progress across its growth initiatives. These include increasing the reach of its tech-enabled solution into new markets. I think the only thing that is really depressing ZG stock price/valuation at the current levels is the bad macro environment that I expect to remain at depressed levels for the short term until interest rates (which impact mortgage rates) revert to norm. Overall, the environment is still tough, but ZG is performing well despite it, and the improved guidance from management for 2Q23 gives me hope that things may be beginning to stabilize. In addition, I now have more faith in ZG's long-term profitability after its first-quarter results confirmed its business model's ability to continue expanding margins.
Premier Agent outperformance
Cycling back to the point on the weak market environment and ZG's strong execution, I think the strongest proof of this is the outperformance of Premier Agent against a decline in the housing market . Premier Agent revenue dropped by 16% compared to a much weaker market, which indicates that ZG Premier Agent is gaining market share and demonstrates the effectiveness of its traffic conversion. In my opinion, the popularity of Zillow Premier Agents can be directly attributed to the effectiveness of ZG's innovative offerings, such as virtual tours, Zillow Home Loans, and other similar tools. Zillow's guidance for Premier Agent in 2Q23 is a decline of 13%-9%, which again exceeds management's expectations for the industry decline of -28% to -18%. The outperformance here has strong implications, in my view, as it shows that ZG is able to capture share from subscale and weaker players, which means it will be fundamentally stronger in the next bull market. As economic cycles are inevitable, the fact that ZG can grow bigger and emerge stronger through each cycle is very positive.
Product development
The strength of ZG lies not only in its scale (inventory listings) and brand recognition. Its ability to constantly innovate and drive new products to increase conversion rate is something that should not be overlooked. In previous earnings calls (4Q and 3Q22), management has callout the usage of solutions like interactive floor plans and in-person tours to help convert traffic into Zillow Premier Agent customers. In addition to spending heavily on product development, ZG is also actively investing in enhancing the quality of the Premier Agent partner network by carefully selecting only the most effective partners. I believe this combination will further improve ZG's ability to convert a lead into sales as it has invested in both sides of the equation. Aside from these, I believe AI and how it would benefit/impact ZG was a focus during the earnings call. I don't think AI poses any immediate risk to the online real estate industry, and ZG is prepared to adapt to the changes AI will have in the industry. ZG's lightning-fast rollout of its plugin to power ZG real estate searches on ChatGPT is just one example of how quickly the company is rolling out solutions/tools to adapt to this environment. This exemplifies ZG's proactive nature and lack of complacency. I would like to point out that ZG has been making AI-related investments for over a decade now, beginning with Zestimate. If anything, ZG is already an experienced player using AI in the industry and has the most data in the US that it can feed into the AI machine to grow exponentially.
Risk
ZG runs the risk that its short-term performance will dampen investor enthusiasm for its long-term growth toward its FY25 targets. This is especially for ZG's path towards profits (45% adj EBITDA margin in FY25). The $61-$81 million range for 2Q23 EBITDA was lower than the $89 million predicted by analysts. Despite management's reasonable explanations (a marketing pull-forward from 2H and a marketing push-out from 1Q23), a consistent occurrence of such "disappointment" could lead to consensus being much more conservative in their estimate next time.
Conclusion
ZG continues to demonstrate strong performance and execution, tracking toward its long-term revenue and margin targets. The company's first-quarter results exceeded expectations, with impressive revenue and adjusted EBITDA figures. Management's optimistic outlook for the second quarter further reinforces the positive trajectory. Despite a challenging macro environment, ZG has outperformed in its Premier Agent segment, gaining market share and showcasing the effectiveness of its innovative offerings. The company's ability to consistently innovate and drive new products, coupled with its investment in AI and data utilization, positions ZG favorably for future growth. However, there is a risk that short-term performance may dampen investor enthusiasm, particularly regarding profit growth targets. It will be crucial for ZG to address any potential concerns and maintain consistency in its performance to sustain long-term growth.
For further details see:
Zillow Group: Strong Execution And Innovative Capabilities