While a large percentage of companies have been beating estimates this quarter, profit growth has come predominantly by cost cutting rather than through expansion of top line sales. For this estimate-beating trend to continue, it has to give way to top line growth.
Zillow, (NYSE:Z), a company with consensus-busting earnings AND revenue growth in the flourishing housing market, may provide additional return potential if the broad market struggles as it approaches 1600 on the S&P.
Zillow: Riding the Housing Boom
Zillow secured its stronghold by becoming a staple for home buyers and sellers, renters, landlords, agents, and developers looking to determine fair market property values. The company aggregates information from publicly available sources such as land records, sale prices, and listing facts, using a proprietary valuation algorithm to generate a database of current pricing information. This information is used to create a “Zestimate” – a general home valuation that buyers, sellers, and real estate professionals can use as a guideline for a property’s real value.
Zillow has blossomed this straightforward business model into a growth powerhouse. In 2011, Zillow had revenues of $66.053M. In 2012, this had grown to $116.85M. For 2013, analysts’ estimates put total revenue at $171.27M, followed by $227.61M for 2014 and $274.51M for 2015. If Zillow meets these projections over the next 30 months, this would be a 32.96% CAGR in revenue growth. Given Zillow’s history of handily beating earnings estimates, this kind of top-line expansion would allow Zillow to continue to build on that reputation.
Certainly much of Zillow’s growth can be attributed to a buoyant US housing market – one of the few resilient segments of the economy. And Zillow’s valuations are not cheap. Significant growth rates are being priced into the stock with a forward P/E of 70 and a PEG of 5.7. However, management has indicated that they see the company as still in its early expansion phase and, with total US real estate-related advertising at $20 billion, they will continue to build out the Zillow brand into niche segments of a very large, fragmented market. The company has over 35 million unique monthly visitors with very strong brand awareness.
Zillow expects to invest heavily in developing a top presence across real estate related markets that will touch everyone from renters to homebuyers to mortgage and real estate professionals. This build-out will consume a considerable portion of revenues and keep quarterly EPS in the range of $0.06 to $0.15 through the remainder of 2013. Over the next couple of years, however, core EPS is expected to grow by 148% and 51% respectively.
Knowing the Risks
Being tethered to the housing market has been a boon this year but this good fortune could change rapidly. Zillow’s own Home Value Index for the metropolitan areas of Phoenix, Las Vegas, San Francisco, San Jose, and Sacramento in Q1 2013 show year-over-year growth over 20%. For many, this kind of growth in home prices flashes warning signals that the resurgence in US housing is becoming unsustainable and portends more volatile downward swings rather than stabilization. For the US as a whole, the Zillow Home Value Index was up 5.1% YoY as of March, marking the sixteenth straight month of appreciation. Zillow will benefit if this growth continues; the issue is how well it can weather a downturn. Zillow’s exposure to the housing market remains cyclical and given its rich valuation, investors may be quick to deflate this premium if housing prices begin to slide.
Also posing a risk are competitors such as Trulia (NYSE:TRLA), Move Inc. (NASDAQ:MOVE), and potentially Google (NASDAQ:GOOG). Zillow has first-to-market brand recognition but the nature of their business makes competition highly fluid and unpredictable. Zillow will need to maintain the edge on innovation and continue investing in brand recognition.
On a Tear
Click to EnlargeZillow has appreciated 143% since November 2012. So to be clear, Z is an aggressive growth stock that has sentiment and momentum on its side. When that changes, the volatility to the downside can be fast and painful. However, the market is rewarding high growth stocks with high potential for revenue growth – and Z fits the bill. As long as this trend continues and the market maintains its bias towards risk-on mode, Z could see substantial upside, even from current levels.
Z’s uptrending channel is steep, with the $55 price level representing the lower end of the channel. Pullbacks towards that lower end may not last long and entries within this channel may be more ideally suited for momentum and swing trades.
Longer term, Z has significant support near $45. Given the consolidation that took place beneath this level and the breakthrough the stock made in early March, price action indicates that this would be a key technical level on any pullback. As such, it would mark an ideal buy limit point for investors with longer term horizons. For investors that are looking for an aggressive growth stock while gaining alternative exposure to the US real estate recovery, Zillow may be the right candidate.
Recommendation: Accumulate Z at the low end of its uptrending channel as an aggressive growth stock. A $45 buy limit would be suitable for a longer term horizon.
Options Alternative: Buy to open the August 60 calls for $5.50 or less on pullbacks. The calls have run up ahead of Zillow’s earnings report Tuesday, May 7, so try to enter on pull backs, but no need to chase the price as we have plenty of new recommendations.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.