Realogy Holdings Rebounds Strongly
- The company was cruising in Q1 with double digit volume growth but then the pandemic struck taking volumes deeply negative.
- The company reacted swiftly with additional cost cutting and an accelerated shift in technology uses like virtual visits.
- While the shares are cheap and the market could very well recover rapidly, we won't buy until we see a turn-around in cash flow.
The Armageddon that investors in Realogy Holdings (RLGY) expected doesn't seem to be materializing in quite the destructive way investors positioned themselves for in March.
However, the stock has already rebounded strongly, albeit from extremely depressed levels. Market stabilization and recovery and quick company reaction is likely to provide some further mileage to the stock, but the biggest gains are behind us.
Astute swing traders could have made an absolute killing trading Realogy Holdings, the shares absolutely collapsed in March and have already more than tripled since although still quite some way from their February heights:
Needless to say, the impact of the COVID-19 pandemic has been less than initially feared. The pandemic is a most unwelcome interlude as the company was actually on a pretty decent run, as we reported in our January 31 article.
The problems it was struggling (and seemingly in the process of overcoming) back then, like competition for agents, seem to belong to an altogether other area already.
Don't be scared by the above crash in net income, these are GAAP figures driven by a $441M (non-cash) impairment charge and a $38M net increase in interest expense due to the mark-to-market adjustments on interest rate swaps.
COVID-19 impact and reaction
The company was basically cruising when COVID struck:
- Franchise and brokerage volume was growing 12% in the first half of March, then declined 10% in the second half.
- Closed transaction volume down 20%-25% in April, with significant geographical variation (NY City, California and New Jersey the strongest hit).
- Open transaction volume down 40% in franchise and 50% down in brokerage, with the same geographical variation.
- Change in mix towards the lower end with substantially fewer $1M+ houses going under contract in April.
- The decline has hit a peak mid-April, there is some improvement since.
- Surprisingly perhaps, consumer searches are substantially up on their websites (and other related ones) with a notable increase in interest in suburban houses.
- Refinanced volume is up substantially, not surprisingly given the collapse in rates.
Basically here is the upshot, according to management (Q1CC):
So overall kind of based on what we're seeing, we believe there's going to be pent-up inventory and consumer demand post-COVID. Since housing is not a perishable good, we believe the listing and transaction volumes will improve in geographies as they reopen. We are seeing a bit of green shoots already in our weekly data from select geographies
The company reacted quite speedily to these fairly dramatic changes, from the earnings deck:
The company accelerated its technology that enables virtual sales including virtual home tours, virtual staging, new online marketing capabilities, increased digital payment options and the company's remote notarization product for title and flash close product for mortgage and operational changes.
It is also initiating additional $80M-$100M cost savings on top of an earlier program that is already being implemented.
Management also embarked on some balance sheet improvements, it drew $400M of its revolver in March taking the company's cash to $628M at the end of Q1.
The Q1 results were almost an afterthought, given the sudden and drastic change in the environment. But let's not forget, these were pretty good, from the earnings deck:
Given the debt level of the company and the difficult market circumstances, the negative cash flow might look a bit scary at first sight, but the company is still solidly cash flow positive for the year and this was the result of deferred tax (see below).
Volume growth was good at 8%, but that declined towards the end of the quarter, needless to say.
Splits were a main concern before COVID-19 struck and the company had already been on the way of producing some improvements. However, how COVID-19 will affect these is still difficult to forecast. Splits mostly depends on the agent mix but it also to some extent on geography and with respect to the latter, it's hard to tell which geographies will come back first.
What seems to be happening at present is some reversal as more transactions come from agents higher up the split table (as one analyst put it on the Q1CC, "better agents do more deals in tough times").
There is another slide in the deck with the main drivers:
There are those, like NAR and Fannie Mae that see a rapid recovery in the housing market and website visits from consumers are up substantially, but management says it is prepared in case this doesn't pan out.
These are GAAP margins establishing a clear seasonal pattern which should be no surprise. But one can spot the moderate downward trend in both gross as well as operational margins over time.
The company was already executing a prior cost saving program ($70M-$90M, consisting mainly of workforce and office footprint optimization) independent of the ($80M-$100M) COVID program mentioned above that is already partly executed in Q1, from the Q1CC:
So, it's relatively straight lined the $70 million to $90 million. So it was slightly higher in the first quarter, so slightly more than a quarter's worth of that, but it's relatively straight lined. As far as the bits of brokerage versus franchise, it was predominantly on the brokerage side but you would also see some in franchise and in corporate.
On a more positive note, operating EBITDA reached $37M with the margin improving 300bp (this is from continuing operations as their relocation business is discontinued).
Cash flows are declining and Q1 was actually negative, from the 10-K:
Although most of that came from the $128M in deferred income tax, without which operational cash flow would have displayed a slight positive, and we're not sure what their deferred tax situation is longer-term.
Deferred tax is the result of GAAP accounting difference from the IRS and the most common source here is difference in depreciation methods but we could not find anything on this in the 10-Q. From the 10-K, we find this:
It doesn't seem to be a structural problem but they carry $390M as a liability on the balance sheet at the end of last year which has been reduced to $253M at the end of Q1.
Still, the deterioration in cash flow over the last couple of years is quite worrying. The cost initiatives seem to be imperative especially given the headwinds from the pandemic.
The company provided an overview of their outstanding debt, from the earnings deck:
The company had already taken some measures to improve leverage like eliminating buybacks and the dividend since last year. It has to be said, these share buybacks worked:
The declining cash flow and elimination of dividends and buybacks have made investors much less willing to pay up for the shares, and quite frankly we can't blame them.
Analyst expect an EPS of $0.16 this year rising to $0.65 next year, which would make the shares really cheap.
The company wasn't as hard hit by the pandemic (at least so far) as investors feared, and took swift action reducing cost, the share price has recovered nicely from the COVID-induced crash to unimaginable lows.
While some might consider the lessening of the competitive environment as the first green shoot in the recovery of the company, we still worry a bit about the company's structural decline in cash flow and the large debt.
While the shares are cheap, and according to authoritative market watchers the market will recover rapidly, we would like to see at least a stabilization of the cash flow, if not an uptick before we would consider buying the shares.
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