Zillow: Growth to Improve Against an Improving Macro Background (NASDAQ:ZG)

Summary

Following my coverage of Zillow Group (NASDAQ:ZG) in May’24, for which we recommended a buy rating due to various visible growth catalysts that can help support growth among teenagers, this post is to provide an update about my thoughts on business and stock. ZG maintains a buy rating as the growth outlook has brightened due to an improved macro context. Additionally, execution on improved penetration markets and improved top-of-funnel awareness continues to be solid. The market seems to be appreciating the strong results as well, as seen in the stock price movement.

investment thesis

On 07-08-2024, ZG released its 2Q24 earnings, which posted revenue of $572 million, 6% ahead of consensus ($538 million). Total revenue increased 13%, driven by the residential segment which increased by 7.6% to $409 million, the mortgage segment by 41.7% to $34 million, the rental segment by 28.6% , up to $117 million, and others increased by $12 million. EBITDA total adj also had better than estimate, coming in at $134 million, ahead of consensus of $99 million by 36%, implying an adj EBITDA margin of 23.4% (vs. 2Q23 of 21.9%).

ZG’s 2Q24 results allayed my concern about the residential segment as it fared much better than guided (previous guidance called for $372 million to $382 million, but 2Q24 reported $409 million). 2Q24 was also another solid quarter of equity gains as the residential industry grew just 3%, implying that ZG gained ~500bp of share. With various macro indicators pointing to a positive growth outlook for the US residential housing market (as I wrote in my post for The Middleby Corporation and quote below), I predict that this segment will see solid growth accelerate in the coming years.

1. Housing starts have continued to improve since the May saw.
2. Existing housing stock has improved since the start of the year.
3. Mortgage rates have fallen, which should continue to fall as the rate of diet cuts, and this should cause the two points above to further improve (lower rates boost housing demand , which drives housing starts; lower rates cause more existing homeowners to list). housing, which improves the housing supply situation).

Furthermore, ZG has invested heavily in the top of the funnel, which now gives it a dominant position over even its closest peers. This further supports a solid growth outlook when the demand situation recovers.

And our top of the funnel advantage today has never been stronger. Zillow was searched more on Google than the real estate category term and three times more than the next brand in the category. 80% of our traffic is organic and our app usage is over three times anyone else in the category. We have more than 217 million average monthly unique users across the Zillow ecosystem of apps and websites and 109 million total unique visitors, according to ComScore, a third-party data tracking tool that enables cross-site comparison. 2Q24 earnings results call

Recall in my previous post that the second growth catalyst – ZG’s expansion into enhanced markets – continued to perform well in 2Q24. To recap, management’s target was for ZG to penetrate the enhanced market 40. In 2Q24, ZG has penetrated 6 additional markets (19) and is on track to reach 36 markets by the end of August, which means it is well ahead of schedule to reach its target of 40. As mentioned earlier, about the implications penetration of these markets:

Since home loan products are typically associated with transactions in enhanced markets, penetrating these markets also brings the advantage of higher revenue per transaction.

Management provided an updated figure this quarter that allowed investors to better quantify this revenue growth in these markets. Using the four most mature enhanced markets as benchmarks, management noted that revenue growth per total deal value has increased by more than 80% since the start of 2023. Even considering that not all markets will achieve this level of growth, is still a substantial increase even at a 50% discount (ie a 40% increase in revenue per transaction). The markets that ZG entered in 1Q24 also experienced positive growth; as such, I expect mortgage income to continue to grow at robust rates as ZG penetrates more improved markets. Another benchmark to show the effectiveness of this strategy is the fact that ZG Loan home purchase loan volume grew 125% y/y to $756 million in 2Q24, despite the mortgage market declining by single digit y/y.

In our top four improved markets, we’ve seen revenues per total deal value increase by more than 80% since the start of 2023, compared to the more than 50% growth we reported on the February call. 2Q24 earnings results call

On the last growth catalyst – rentals – it was another solid quarter of performance where ZG achieved its eighth consecutive quarter of growth. I don’t see any sign of slowing down here as ZG flyers continue to drive growth where they continue to add significant housing units (multifamily listings up 38% y/y to 44,000 properties) which is attracting more consumers (multifamily). revenues rose 44% in 2Q24, showing that new supply is translating into new homes), which in turn is attracting more homeowners to list their homes. With increased investment in brand marketing campaigns, ZG’s growth outlook remains solid in my view.

ASSESSMENT

Based on how the stock price moved after the earnings, the market clearly loves this set of results. As I’ve always been bullish on ZG since I started covering this stock, my focus is always on when ZG can achieve its long-term goal of $5 billion in revenue and a 45% margin. Based on recent performance, where growth should accelerate (starting 1H24 13% revenue growth) given the positive setup ahead, I think my 17% CAGR (through FY29) assumption still holds. I am also still optimistic that the adjusted EBITDA margin can reach 45% by then, which translates to $2.245 billion of adjusted EBITDA in FY29.

In my last model, I used the S&P500 historical average EBITDA multiple to value the business. This appears to be too conservative as the market today values ​​ZG at 20x forward EBITDA. Assuming ZG stays at this level longer, the upside will be much more significant than I originally modeled (ZG’s share price peaked at $212, so there is precedent for the share price to hit my $192 case).

Risk

The ongoing NAR settlement case is the biggest risk for ZG. Z relies on brokers buying leads and ads for revenue, so if commissions were to drop, brokers could cut expenses. I should also mention that the need to have written agreements with homebuyers before doing a tour is a big friction that may limit ZG’s ability to grow.

Conclusion

In conclusion, my rating for ZG remains a buy. 2Q24 results exceeded expectations on all key metrics and with the significant share gained, ZG further consolidated its market leadership position. With an improving macroeconomic context, coupled with ZG’s strategic initiatives in improved markets and top-of-funnel dominance, I expect growth to become more robust.