Rollover stocks are always tempting because they usually look cheap and the upside is significant if the rollover is successful. But inherent in the fact that this is a turnaround is the fact that there has been a long-term decline or stagnation in activity up to the point of analysis. This means that in general, growth, tailwinds and a proven track record are not on your side if you are an investor in the business. There is also usually a high net leverage ratio.
Anywhere Real Estate Inc. (NYSE: HOUS) falls into this category. The stock is down 80% from its 2013 high. Revenues are up about 50% since then, but earnings are flat, so most of the decline can be attributed to the squeeze multiple.
In 2013, the stock reached a peak EV/EBIT multiple of approximately 40 with $525 million in EBIT and a stock price of $50. Today, the EV/EBIT multiple is around 9, 2021 EBIT was $600 million, and the stock is trading at $10. It paints a picture of the market slowly losing confidence in the business over a decade as margins have fallen due to increased industry competitiveness as growth has failed to compensate.
This brings us to where we are now. What future for Anywhere Real Estate? Along with Realogy’s rebranding, management has charted a course for sustained growth and increased profitability, with the main points being more cost-cutting measures to improve profitability and “high-impact technology” that improves agent efficiency. It’s a nice plan in theory but I wouldn’t bet on this turnaround to succeed in the long run. I think it’s a company in decline and the title will continue to reflect that decline.
If I’m right, this will all be evident over the next 5-10 years. But could there be a short-term benefit? The market appears to be pricing in a real estate crash scenario for some stocks (primarily thinking of home builders and housing supply companies) and this could spill over into the brokerage sector. The current slowdown will likely continue, but I don’t think the “housing bubble 2.0 burst” scenario will materialize. Even so, the market fears a real estate crash and shares of Anywhere Real Estate could be difficult to hold, especially if investors do not believe in the long-term recovery plan.
The recovery plan
Management has focused on cost reductions as the primary means of increasing profitability. In the Q2 2022 press release, they highlight up to $140 million in potential savings for the year. The cost savings are good, but the counterbalance to that is that the brokerage industry is becoming much more competitive. As this trend continues, the distribution of commissions on real estate transactions will become even more favorable to the agent. There isn’t much loyalty when it comes to choosing a brokerage; agents will go where they can make the most money. The distribution of commissions is not the only factor in this equation, but it is an important factor.
Along with cost savings, Anywhere touts its “high-impact technology” that makes agents more efficient. I’m not an agent, so I’m not an expert on the different real estate platforms and the technology associated with them. But that’s the type of statement that I can’t trust at face value. In fact, given the constant evolution and improvement of software, I think that statement may not necessarily hold true for a long period of time, as the company is cutting costs rather than aggressively investing in its platform. It would be less of a concern if it was a low churn type of business, but as I mentioned, agents will always go to the brokerage where they can make the most money. If Anywhere’s technology starts to lag behind as other brokerages invest heavily in their technology over the next few years, agents will leave.
Like most turnaround stocks, Anywhere Real Estate looks cheap. It currently trades at an EV/EBIT multiple of 9 and compared to other publicly traded brokerages that have much higher earnings multiples or are unprofitable, it feels like a steal. But it’s worth digging a little deeper.
First, the company over-earned in 2021. The multiple will increase over the next two quarters as earnings decline in the second half of the year, just as earnings declined in the first half. The EV/EBIT multiple could be closer to 12-15, which is roughly in line with the stock average from 2015 to 2020.
Second, it is interesting to check how these gains translate into cash flow. In the first half of 2022, changes in working capital impacted operating cash. Not too much of a concern as I expect them to normalize in no time. What stands out is that capital expenditures are relatively high. Looking closer, we can see that this is because property, plant and equipment is mostly capitalized software. This improves the appearance of earnings under GAAP, although free cash flow and total earnings over time would remain unchanged. If software costs were instead expensed in the income statement, the current EV/EBIT ratio would not be as good. It wouldn’t affect the economics of the business, but it’s something to keep in mind.
Finally, this is not the right macroeconomic environment to hold highly leveraged recovery stocks, especially if the company operates in the real estate sector. I said I don’t think there will be a big real estate crash, but the stock market is very nervous with the real estate market data. Take a look at the valuations of major residential construction companies. DR Horton, Inc. (DHI) is trading at an EV/EBIT of around 4, below the lows of the 2020 covid crash. Companies in cyclical industries see a range of earnings multiples depending on the part of the cycle in which they are at, but with this type of valuation, the market is pricing these companies for a huge slump in earnings.
DHI is up about 25% from its recent lows and most housing-related stocks are up, but any more worrisome housing data could push those stocks down. Highly leveraged companies like Anywhere Real Estate could be auctioned off even more due to existential business fears.
Despite management’s best efforts, I don’t see Anywhere Real Estate emerging from its decade-long trend of stagnation. The real estate brokerage industry is changing incredibly fast and becoming very competitive, so it will take innovation and competitive pricing to be successful in the future. Anywhere Real Estate has brands with a large market share, but it’s not a high-fidelity business; ultimately, agents will go where they can make the most money. With its cost-cutting mindset, I don’t think Anywhere Real Estate will technologically or culturally follow in the race to improve agents.
I also wouldn’t feel comfortable betting on the short-term stock. It looks cheap on an earnings basis, but it over-earned in 2021 and the earnings multiple will pull back in the coming quarters. It is also highly leveraged with a net debt to EBITDA ratio of 6x based on annualized H1 2022 EBITDA. This will make it more susceptible to a continued real estate recession or fears of a more aggressive real estate recession. This could create an opportunity for investors who believe in the long-term story, but it could make the stock difficult to hold in the short term.