Stockwatch: A classic mature bull market play

Does a 24% drop in this AIM-listed “disruptive” estate agency Purplebricks (PURP) represent a buying opportunity or reversal to a downtrend?

At about 400p after a 514p peak, twice reached in July and August, the stock needs fresh support to sustain an upward trend-line from just over 100p at the end of 2016.

The table shows how a market value near £1.1 billion discounts a great deal of anticipated progress in the US housing market especially, where the company is currently launching.

Say Purplebricks was making £50 million pre-tax profit a year, hence earnings per share (EPS) of about 15p, this would represent a price/earnings (PE) multiple near 27 times.

That’s not to say it can’t trade higher in the longer run if the tide of house-trading turns in the company’s direction, though downside risk is stark should the mood towards the stock falter.

Currently, it’s a tussle where the balance of buyers/sellers – how sentiment reacts to news and events – is most significant, hence traders are likely to take their cue from the chart.

A genuine revolution in property sales

Purplebricks is fast gaining traction: see its House For Sale signs multiplying across the UK and its prominence in online searches (72% share). It has twice had its knuckles rapped by the Advertising Standards Authority and one wonders whether constant rave-reviews on the Trustpilot review site have been “planted”.

Yet its concept of paying a set commission up-front cuts through stagnant aspects of the housing market, for example where elderly home-owners sit out with an unrealistic sale price, hoping to downsize with a fat pension pot, or those just “testing the water”.

An up-front approach makes vendors more realistic as to price and speeds up the process, thus creating strong revenue growth as shown in the table.

With US property sales based on commissions over 5% relative to circa 1.5% in the UK, Purplebricks is potentially on a massive roll unless the industry adapts its business model soon. Mind that its shares can still be overvalued after an exuberant run in the last 10 months.

Rightmove: a bit invidious comparison

Rightmove (RMV), the £3.7 billion FTSE 250 (MCX) online estate agency, hasn’t had the cojones to take on the US, but is comparatively the investment-grade stock with a proven earnings/cash flow/dividend record.

This has been helped by an operating margin well over 70%, something Purplebricks is nowhere near proving. Yet it hints at the financial potential of being a disruptor in this industry: pre-tax profit growing from about £80 million in 2012 to an expected £200 million by end-2018.

A high share price means a yield of only 1.5% despite about a third of earnings distributed, although the more speculative Purplebricks is nowhere near paying out.

Over recent years Rightmove has averaged an historic PE multiple in the mid-30s, but since end-2015 its stock has traded volatile-sideways as traders have turned wary it can rally, given the forward PE multiple is twice its expected earnings growth rate.

Thus, Rightmove also serves as a reminder it tends to be “better to travel than arrive” where high expectations are involved.

Purplebricks Group           Consensus estimates year ended 30 Apr 2013 2014 2015 2016 2017 2018 2019 Turnover (£ million)   0.01 3.39 18.6 46.7     Net interest paid (£m)     0.01 -0.04 -0.06     IFRS3 pre-tax profit (£m) -0.52 -2.34 -5.44 -11.9 -6.06     Normalised pre-tax profit (£m) -0.52 -2.34 -5.44 -11.9 -6.06 -12.6 6.56 Operating margin (%)     -160 -64.2 -12.9     IFRS3 earnings/share (p) -0.22 -0.86 -2.26 -12.0 -1.0     Normalised earnings/share (p) -0.22 -0.86 -2.26 -12.0 -1.0 -4.48 0.35 Price/earnings multiple (x)         -390 -87.0 1126 Cash flow/share (p) -0.16 -0.96 -1.97 -7.01 -1.68     Capex/share (p)       0.54 0.85     Net tangible assets per share (p)       11.5 25.9     Source: Company REFS              Directors have ensured to lock in gains

Last March, Purplebricks’ directors cashed in 2.9% of the company for £23.8 million at 300p per share, the chief executive disposing of 3.7 million shares to retain 37.7 million (14%) and the chief financial officer 1 million shares retaining 1.1 million (0.4%).

So these key individuals both have skin in the game, although without knowing how the share capital was structured pre-flotation it’s entirely possible the chief executive has taken out at least any investment cost.

A sceptic might add that he sold the maximum possible without disrupting sentiment, and that the finance officer’s selling nearly half his stake is more indicative.

Then in April the senior non-executive director sold 1.6 million shares around 300p, retaining nearly 5 million shares, and in early August the lettings director sold a total 60,000 shares averaging around 485p to net £288,775.

This follows various insiders’ sales (after exercising options) around Christmas/New Year. They have certainly used wider appetite for Purplebricks equity to manage their own risk exposure, though like anyone else they can’t know how successful the US launch will prove – now the crux for valuation.

Only a small share of the vast US market is needed

Last February, £50 million was raised gross via a 22.7 million share placing at 220p, representing 9% dilution, to fund this development.

A 15 September announcement has affirmed the formal launch with California the first state target, ranking number 1 in US transactions with total commissions over $11.5 billion (£8.5 billion). A region by region roll-out will be pursued in due course, as per the UK and Australia (8% of group revenue in the last year to end-April).

The technology platform and customer offering is said to be tailored to address intricacies of the US market and also provide local experts.

Typically, there are agents on both the buy and sell side, the selling agent seeking 5-6% of the sale price; whereas Purplebricks will charge a flat fee of $3,200 to list a property, with sellers to pay an additional 2.5% commission on closing.

Thus, it is claimed to save sellers $16,400 on an average Los Angeles house price of $560,000, where Purplebricks is starting TV adverts. Buyers can tour properties online in 3D virtual reality, arrange visits, submit offers and negotiate sales directly with buyers; there’s also currently a $1,000 cash incentive for buyers to select Purplebricks as agent, payable on closing.

With management’s long-standing US experience they ought to take share enough for this to become a substantial business; the question for valuation being “just how much”? Time will tell but if profits on a Rightmove scale are realistic to entertain then there’s medium-term upside.

Trading update due Friday 29 September

This will likely be a short-term crux. Not only must it come across impressively, it also has to overcome buyer fatigue otherwise bear traders will assume confirmation.

There’s very little disclosed (above 0.5%) stock on loan – just 0.7% of the issued capital in respect of Numeric Investors LLC which last increased its exposure by 0.08% on 27 July.

That may reflect lack of liquidity by way of other parties willing to lend stock rather than a consensus verdict Purplebricks isn’t overvalued.

This is a classic mature bull market play, typically bought in the belief it can “grow into its valuation” – which indeed it can on a three-to five-year view. For now, mind the downside risks until progress and the chart re-affirm a bullish trend.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.