Compass: This Real Estate Titan Is Too Good Of A Steal To Pass On (NYSE:COMP)

Real estate agent showing the outdoor areas of a property to a client

Hispanolistic/E+ by using Getty Photographs

No investor wishes to touch Compass (NYSE:COMP) appropriate now, and the factors for that are straightforward to have an understanding of. It is really a expansion stock that is now getting rid of funds, which is one particular of the worst places to be in in the course of the risky 2022 market. On prime of that, it really is a serious estate enterprise – and with increasing charges and continued inventory tightness, all signs are pointing to a slowdown in transaction volumes, perhaps to start in the back again 50 percent of this yr.

But as standard, the market is getting a really shorter-sighted method to this stock. When I acquire a step again from the brief-time period sounds on Compass, I still see a company that has immediately boosted alone to the prime of the U.S. real estate marketplace within a rather shorter range of several years. It has come to be a household model identify for each dwelling purchasers and sellers, and has managed to continue attaining industry share in an period exactly where extra business enterprise is supposedly shifting to low cost brokerages like Redfin (RDFN).

12 months to day, shares of Compass have shed 40% of their price as opposed to highs above $17 that Compass notched past August, the stock is down by extra than two-thirds.

Compass stock price
Info by YCharts

The Compass bullish thesis revisited

Given the steep drop in Compass inventory over the previous few months, even with the point that elementary overall performance proceeds to keep up, I’m upgrading my see on the stock to sturdy get. I suggest that traders double down on this dip as I have, and while Compass could have a rocky couple months forward as genuine estate action most likely slows down (while I’d argue this fear is now baked into its inventory cost), it is continue to well-positioned to be a lengthy-phrase winner.

Here is a full rundown of the good reasons to be bullish on Compass:

  • In just a couple of several years, Compass has come to be a dominant brokerage. Compass’ market share of U.S. real estate transactions is expanding promptly to ~6%. Previously deeply embedded into major coastal markets, Compass is a lot more not too long ago pushing into new workplace prospects in the Midwest. There is still space for more expansion: Even after the new industry action this year, Compass is nonetheless penetrated into a lot less than half of the U.S. population.
  • Tertiary income possibilities. A short while ago, Compass has been opening the door to new monetization possibilities, together with starting its very own title enterprise. This positioning will help Compass derive much more wallet share from authentic estate transactions as a entire. Compass has commented that connect premiums on these tertiary products and services are rising. Compass estimates its U.S. TAM is $240 billion, of which only $95 billion and the rest is coming from adjacent solutions.
  • Sturdy branding. Compass developed a model all-around being a comprehensive-support, superior-good quality authentic estate brokerage, extremely equivalent in type and profile to rivals like Berkshire Hathaway Dwelling Products and services or Sotheby’s. This gives the company a extremely powerful distinguisher towards other tech-initial rivals like Redfin.
  • Scalable system. Compass’ principal fees lie in the R&D invest to produce its technologies system for Compass brokers, as perfectly as the profits and marketing and advertising expenditures of advertising and marketing its brand name to homebuyers/sellers and prospective new brokers. These expenditures are scalable: as Compass’ scale grows, and as agent productiveness grows (the average Compass agent generates 19% a lot more product sales in the second 12 months), Compass will be equipped to enhance its profitability margins, which we have by now noticed in the company’s latest outcomes.

Note as very well that Compass has guided to “at least breakeven” adjusted EBITDA this yr on a revenue profile of $7.6-$8. billion (flat to previous 12 months, in which the organization created $2 million of modified EBITDA), and that by 2025, the firm is aiming to deliver $1.2 billion of modified EBITDA. We’ll take a look at the math guiding this in the up coming portion.

Compass 2Q22 and FY22 outlook

Compass outlook (Compass Q1 earnings deck)

In the meantime, at current share rates close to $5, Compass trades at a current market cap of just $2.33 billion. After netting off the $475.9 million of income on Compass’ most current harmony sheet, the company’s ensuing organization worth is $1.85 billion. This implies Compass is trading at a fraction of this year’s expected revenue, and at a <2x multiple of its 2025 targeted adjusted EBITDA.

There’s a huge opportunity here to be seized: don’t miss the chance while the entire market is looking the other way.

The path to profitability lies in adjacent services

One of investors’ biggest criticisms with Compass is that the company effectively bought its growth. This is, admittedly, partially true: Compass achieved tremendous market share so quickly because it took the approach of buying out existing brokerages and slapping the Compass logo on them. The argument that Compass makes in defense of this strategy, however, is that agent productivity rises over time (especially as agents are onboarded onto the Compass platform and brand) and that it will wring out profits on its acquisitions over time.

In 2021, the company achieved breakeven adjusted EBITDA margins. By 2025, the company aims to grow its revenue base by ~50% to ~$12 billion, and generate ~10% adjusted EBITDA margins on that revenue.

Compass operating model

Compass operating model (Compass Q1 earnings deck)

As can be seen in the chart above, the majority (450bps) of this adjusted EBITDA expansion from flat to ~10% margins is expected to be derived from better transaction economics. Of particular importance to Compass’ strategy going forward is expanding its adjacent services in other words, offering title, escrow, and mortgage services to the buy-side of its transactions.

The chart below illustrates the incrementally of these offerings. Title and escrow alone can nearly double Compass’ net revenue per transaction, and mortgage offerings through the company’s new OriginPoint subsidiary can deliver substantially more than that.

Compass adjacent services

Compass adjacent services (Compass operating model)

Note that these are relatively newer offerings. OriginPoint originated its first mortgages just in Q4. And in May, Compass acquired a title company called Consumer’s Title Company of California, which is licensed in every county in the state of California. At present, title and escrow services are only used on a mid-single digit percentage of Compass’ buy-side transactions, pointing to massive opportunity for the company to continue to cross-sell this product with its agents.

Growth still robust

And despite fears of a near-term housing market collapse, we haven’t seen any deterioration just yet in Compass’ results.

In Q1, Compass grew its revenue at a robust 26% y/y pace to $1.4 billion, representing a Q1 record for the company. The chart below shows as well that Compass ended Q1 at a 5.8% trailing twelve-month market share of U.S. real estate, up 150bps y/y. For Q1 alone, Compass’ market share was even higher at 6.1%, up 90bps versus 5.2% in the year-ago Q1.

Compass growth metrics

Compass growth metrics (Compass Q1 earnings deck)

Agent productivity also remains incredibly high. Compass isn’t just growing by adding more agents to its network, its agents are also producing much more than the industry average. As shown in the chart below, the average Compass agent generated $10.6 million in gross transaction value over the past twelve months – which is 3.5x more than the typical agent in the industry.

Compass agent productivity

Compass agent productivity (Compass Q1 earnings deck)

Here’s some helpful anecdotal commentary from Compass’ outgoing CFO Kristen Ankerbrandt on how the company is seeing the real estate market shape out for the rest of the year, made during her prepared remarks on the Q1 earnings call:

The first six weeks of the second quarter have resulted in tougher times across all industries. These headwinds along with constrained inventory contributed to a slower start to the second quarter than we expected. As a result our Q2 revenue outlook was affected as you will see in our second quarter guidance.

But despite uncertainty in the current macro environment, we still expect market growth in our markets in 2022 as a result of strong continued demand and historically low inventory that is driving prices higher. Home prices would have to reverse their current upward trend and fall dramatically to turn market growth negative. We do not believe this will occur particularly with prices in our markets continuing to increase.

Key takeaways

I remain focused on the long-term opportunity for Compass to continue gaining market share and driving significant margin expansion through improved agent productivity and cross-selling adjacent services. The long-fragmented and localized real estate industry is moving toward national consolidation, and Compass has emerged as the leading national brand. Stay long here and buy the dip.