Will RE/MAX Shares Continue Marching Higher?

| About: RE/MAX Holdings, (RMAX)
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Summary

Shares of real estate business RE/MAX have been on an impressive upward trajectory over the last couple of weeks.

The firm has consistently generated impressive financial results during its tenure as a public company, returning value to shareholders through both stock price increases as well as a dividend.

Although the housing market is relatively flat, and RE/MAX may face some challenges, the future looks bright for the Denver, Colorado-based firm.

RE/MAX Shares: Up, Up, and Away!

Denver, Colorado-based RE/MAX Holdings (NYSE:RMAX) has been firing on all cylinders recently, as its latest quarterly report has powered its stock to new heights.

Are the past couple weeks an indicator of good things to come, or should investors stay away from the stock at these valuations? I believe that RE/MAX is a relatively low-risk way to bet on the recovery of the housing market, has strong financials to back up its valuation, and poses a great investment opportunity for the long haul.

RE/MAX's Stellar Financial Indicators and Structure

RE/MAX is one of the world's leading real estate brokerage franchises, with nearly 98,000 agents conducting business in 97 countries. Its franchise model is excellent at converting earnings to free cash flow. RE/MAX's profit margin stands at 7.45%, its operating margin at 33.98%, its return on assets at 11.87%, and return on equity at a whopping 793.53%. If we take RE/MAX's revenue of $168.65 million and its operating free cash flow of $30.75 million, we see that RE/MAX converts about 18% of its revenue into workable cash. This gives RE/MAX flexibility for potential mergers and acquisitions as well as for returning value to shareholders through dividends. Speaking of dividends, RE/MAX followed through on its pledge to initiate a dividend and currently touts a 25 cents per share dividend.

We can further understand RE/MAX's smart capital allocation from Seeking Alpha writer Mike Arnold: "The beauty in the RMAX franchise model is that it is capital light, and derives nearly 60% of its revenue from fixed, monthly contractual cash flows from its agent network. It also earns variable commissions on the deal flow coming through the RMAX conduit. In my view, RMAX has a safe business model and has built an enviable moat around its RMAX brand. It also has highly visible and consistent revenue streams, which are easily scalable with little capital investment..." RE/MAX's business model affords its investors to benefit from the housing market while taking some risk out, because management doesn't need to worry about financial leverage or ownership of real estate assets. Rather, RE/MAX can focus on continuing to deliver high-margin profits from the fees their agents collect.

RE/MAX, with its smart capital allocation and low overhead costs, has seen strong financial results in its tenure as a public company. In the latest quarterly report, RE/MAX saw its agent count increase to 97,647, up 5.3% from the same period last year. Revenue and earnings per share also came in strong, at $44.2 million of revenue and $0.44 EPS. Agent count and revenue are both vital statistics for the company, as its franchise model is heavily reliant upon an increasing agent count. All of these indicators go to show that RE/MAX has smart management at the helm and is poised to continue benefiting from its business model.

The Macroeconomic Perspective

Although RE/MAX's model is not as heavily reliant upon fluctuations in the housing market as other real estate stocks, what's going on in real estate does have an indirect effect on the firm's bottom line. With that being said, what lies in store for the housing market in the near future?

The data for the last couple of years shows that growth in the housing market has been relatively flat. The rate of newly built houses and purchased houses has grown, but very slowly. While real estate has recovered from the worst of the Great Recession and has generally produced good results for investors in real estate companies, the sector isn't exactly the hottest part of the economy at the moment.

However, a combination of factors will most likely lead to a resurgence of real estate in the next year. Many consumers are still wary about their economic prospects, and are thus staying on the sidelines when it comes to large purchases, like a new home. But wages may be on the rise soon, which will instill more confidence in consumers. Also, mortgage interest rates have fallen to their lowest levels in over a year, and are expected to rise slowly in the near future. Banks have been loosening up on mortgage lending standards, which will enable more prospective homeowners to qualify for loans. Both increased wages as well as interest rates will lead to an uptick in house sales for the foreseeable future.

Potential Pitfalls

Despite all the good signs for RE/MAX investors, there are some potential pitfalls to be aware of.

Controversy is swirling around RE/MAX because of its operations in Palestinian territory. RE/MAX is currently the largest real estate agency in Israel, boasting 100 branches and over 900 real estate agents in a country roughly the size of New Jersey. But RE/MAX is also seeking to profit from Jewish settlements being constructed in Palestine. The settlement issue has been a big hot-button topic between Israel and Palestine, and pro-Palestinian protestors have urged a boycott of RE/MAX because of the company's actions in the region. Whether or not this issue will prove to be a big hurdle to RE/MAX remains to be seen, but as of the time of this writing, no formal legal action has been taken against the company. The boycott is seemingly only on the fringe at this time, and has seemingly only produced negligible effects. Even if a legal motion is filed, RE/MAX will most likely still profit from their many other markets. A loss in one of RE/MAX's markets can be more than offset by gains in the 90+ other markets.

There is also the potential for RE/MAX's stock price gains to outstrip reasonable valuations for the stock. RE/MAX's price-to-earnings ratio stands at 35.5. In the context of the real estate industry, this ratio is relatively reasonable, but this could change if the stock continues increasing, or if the real estate market continues to stagnate. Analysts at Morgan Stanley have boosted their projections for RE/MAX stock to $39 per share, representing approximately 5% upside to the closing price on December 5th. Prospective investors should keep a close eye on RE/MAX's earnings potential and how that relates to the stock's valuation metrics and future guidance.

Conclusion

With a robust balance sheet, a good dividend, a housing market set to grow, and an efficient business model, RE/MAX stands to continue on its upward trajectory. Despite the potential for operations in the West Bank to flare up and potential valuation concerns down the road, RE/MAX is built to last for the long haul.

Disclosure: The author is long RMAX.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.