Why Zillow Has Investment Potential

The company's strategy could boost its returns

Article's Main Image

Increasing investments in new services and innovation could produce a stock price recovery for Zillow Group Inc. (ZG, Financial). The real estate marketplace is ramping up its home-selling capabilities, which could lead to cross-selling opportunities.

It is also seeking to improve existing offers in order to enhance the customer experience and provide greater differentiation versus its competitors.

Having fallen 22% in the last year versus a rise of 8% for the S&P 500, the stock could offer long-term recovery potential.

889003279.png

Offers

Plans to increase the coverage of Zillow Offers could enhance the company’s financial performance. The home-selling option provides homeowners with a certain and predictable sale within their chosen timeline, which contributed to the company’s outperformance in the most recent quarter.

The company plans to extend Zillow Offers into six additional markets by the end of the first quarter of fiscal 2020. With a presence in 20 markets, Zillow aims to benefit from economies of scale as the size of its operations grows.

There is scope for the company to not only benefit from the profit on the purchase and subsequent sale of homes, but also on adjacent services that are part of housing transactions. These include title, escrow, insurance and moving services that the company is expected to offer over the long run. This could provide homeowners who are looking to move with a suite of products that improve their overall experience and provide Zillow with a competitive advantage.

Innovation

The company is seeking to innovate within its Premier Agent marketplace. It is testing a new model called Flex that is tied to transactions, rather than leads. It achieves this goal through agents only paying a fee when a Zillow lead completes a transaction, rather than paying for the lead itself. So far, Flex has proven to be popular with agents since it more closely aligns incentives and rewards between Zillow and its customers. This could increase loyalty among agents, with there being the potential for Flex to be rolled out across an increasing number of markets in the future.

Zillow is also making changes to its mortgage business. For example, during the quarter, it rebranded the recently acquired Mortgage Lenders of America as Zillow Home Loans. During the integration process, it has also been building a digital mortgage technology platform that will aim to integrate loans with its Zillow Offers service. This could lead to further cross-selling opportunities.

Threats

The outlook for the existing homes market continues to be highly uncertain. Although contract closings in May increased 2.5% from the prior month to an annual rate of 5.34 million, existing home sales data has declined in four of the last six months. Buyers appear to be struggling to find affordable housing, with limited supply likely to cause continued weakness in the sector over the short run. This could cause investor sentiment toward Zillow to remain weak.

Over the medium term, the housing market could be boosted by the prospect of an interest rate cut. Alongside weak existing home sales, jobs growth over the last six months has been disappointing. It has averaged just 174,500 per month during the period, which is down from the 223,000 monthly average recorded in 2018. Further disappointing economic data could lead to an increasingly dovish monetary policy that makes mortgages more accessible to homebuyers. This could increase housing market activity, as well as strengthen investor sentiment toward the industry.

Outlook

Although Zillow is expected to remain loss-making in the current fiscal year and next year, its losses are forecasted to narrow. It is also anticipating a loss per share of 38 cents this year, followed by a loss of 28 cents per share next year.

The continued expansion of Zillow Offers could enhance its competitive position as well as provide cross-selling opportunities.

Innovation within its existing premier agent and mortgage offerings may improve the customer experience, while differentiating the business from rivals.

Having underperformed the S&P 500 in the last year, the stock could offer turnaround potential.

Disclosure: The author has no positions in any stocks mentioned.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.