Down 79%, this growth stock could double in housing returns

It was a torturous August for investors.

After the Federal Reserve closed July holding the benchmark Fed funds rate at 5.25% to 5.5%, where it has been for more than a year, investors called for a reset.

The S&P 500 fell 6 percent in the first three days of trading in August as a slew of weak economic data convinced investors the economy was weakening faster than expected and the Fed erred in not cutting rates.

Stocks tumbled on Monday as a surprise interest rate hike in Japan triggered a global “carry trade” in which investors borrowed low-interest yen to invest in risky U.S. assets such as shares of the “Magnificent Seven”.

Following the steep three-day selloff, economists now expect the Fed to cut interest rates by 50 basis points at its September meeting and by at least another 50 basis points before the end of the year.

The economy will likely remain uncertain, but one thing is clear. Lower interest rates will help revive a struggling housing market, breathing new life into stocks that depend on real estate transactions.

That industry has been hit hard by the housing market slowdown, but a turnaround could be near. One stock that could rise in the recovery is Compass (COMP -1.84%)real estate brokerage no. 1 in the nation by sales volume.

Image source: Getty Images.

Can Compass get back on track?

Compass went public in the spring of 2021, when the housing market was booming and mortgage rates were around 3%. However, that boom didn’t last long, and by 2022, revenues were down and the stock was reeling.

As the real estate market remains on ice, Compass has focused on realigning its cost structure, investing in technology and growing its agent base, which has helped boost revenue even in a challenging market.

Revenue rose 14% to $1.7 billion in the second quarter, and Compass’ core agent count grew 24% to nearly 17,000 as it attracts new agents with an attractive technology platform and momentum constant marketing. After two years of declines in total transactions, business has returned to growth, a sign that the industry is starting to turn around.

Compass is also targeting positive free cash flow this year and making progress on profitability as adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) rose from $30.1 million to $77 .4 million in a seasonally strong second quarter.

The real estate brokerage industry is in a state of flux after a lawsuit against the National Association of Realtors forced brokerages to change their business model with more disclosures and information to clarify that traditional 3 percent commissions are negotiable. As part of the settlement agreement, Compass agreed to pay $57.5 million.

Compass also played down concerns that the settlement would dramatically change the industry, noting in May that in the first weeks after the settlement, 99 percent of new listings included offers to pay buyers’ agents, and 96 percent included commission offers of 2% or more. . Compass believes the deal will have little impact on full-time professional agents.

What lower interest rates would mean for Compass

The housing market will likely never return to the heady early days of the pandemic, when urban Americans snapped up second homes and suburban lots with backyards and mortgage rates fell below 3 percent.

However, there is substantial pent-up demand from home buyers looking for lower rates to effectively lower prices by lowering monthly payments and from potential home sellers who may not want to give up low mortgage rates when rates current are so big.

In June, existing home sales fell to a seasonally adjusted annual rate of 3.89 million, down from a peak of 6.6 million in 2021, a 41 percent decline. Reversing that loss would mean a 70% increase in existing home sales.

Compass doesn’t need that to happen, but even a return to pre-pandemic levels would mean a 50% increase over current existing home sales, and that should make a significant difference to the bottom line. CEO Robert Reffkin told investors this spring, “We think when rates come down, it’s going to create massive transaction growth,” and he predicted the lower rates would mean hundreds of millions in adjusted EBITDA and cash flow. free cash, assuming normalized annual home sales of 5.4. million-5.6 million homes.

The business is already moving in the right direction, with double-digit revenue growth, and growth is likely to accelerate substantially as mortgage rates fall and the housing market rebounds.

Compass stock has already doubled from last November’s low, trending on hopes of a recovery in the housing market and stabilization of its own business. Down 79%, Compass doesn’t need to recoup those losses to be a winner. The stock could double if it retraces just a quarter of those losses.

If the Fed cooperates and the housing market shows signs of life, a double for the real estate brokerage stock here certainly seems within reach.