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

No trader wishes to touch Compass (NYSE:COMP) appropriate now, and the factors for that are simple to understand. It is really a expansion inventory that is currently shedding dollars, which is just one of the worst places to be in in the course of the volatile 2022 market. On major of that, it can be a true estate enterprise – and with increasing charges and ongoing stock tightness, all signs are pointing to a slowdown in transaction volumes, probably to begin in the back again 50 % of this 12 months.

But as normal, the current market is having a really limited-sighted solution to this stock. When I acquire a move back again from the quick-phrase noise on Compass, I nonetheless see a corporation that has speedily boosted by itself to the top of the U.S. true estate industry within just a comparatively small selection of yrs. It has become a house manufacturer name for both house consumers and sellers, and has managed to go on getting marketplace share in an period the place extra enterprise is supposedly shifting to discount brokerages like Redfin (RDFN).

Yr to day, shares of Compass have shed 40% of their worth versus highs earlier mentioned $17 that Compass notched previous August, the stock is down by a lot more than two-thirds.

The Compass bullish thesis revisited

Provided the steep fall in Compass stock above the earlier number of months, even with the fact that basic effectiveness carries on to maintain up, I am upgrading my perspective on the inventory to strong acquire. I endorse that traders double down on this dip as I have, and though Compass may possibly have a rocky several months in advance as genuine estate exercise perhaps slows down (though I might argue this worry is already baked into its stock selling price), it can be nevertheless perfectly-positioned to be a prolonged-phrase winner.

Here’s a total rundown of the good reasons to be bullish on Compass:

• Inside of a few many years, Compass has develop into a dominant brokerage. Compass’ current market share of U.S. genuine estate transactions is increasing rapidly to ~6%. Already deeply embedded into main coastal markets, Compass is much more recently pushing into new office alternatives in the Midwest. There is however place for even more growth: Even soon after the new sector exercise this yr, Compass is continue to penetrated into fewer than fifty percent of the U.S. population.
• Tertiary revenue prospects. Not long ago, Compass has been opening the doorway to new monetization chances, which includes starting up its have title firm. This positioning can help Compass derive more wallet share from genuine estate transactions as a full. Compass has commented that connect costs on these tertiary companies are mounting. Compass estimates its U.S. TAM is $240 billion, of which only $95 billion and the relaxation is coming from adjacent providers.
• Sturdy branding. Compass designed a brand name close to being a total-support, significant-high-quality real estate brokerage, extremely similar in model and profile to competitors like Berkshire Hathaway Residence Companies or Sotheby’s. This presents the organization a extremely potent distinguisher versus other tech-to start with rivals like Redfin.
• Scalable platform. Compass’ key costs lie in the R&D devote to produce its technology platform for Compass agents, as very well as the profits and advertising expenditures of advertising and marketing its manufacturer to homebuyers/sellers and possible new agents. These charges are scalable: as Compass’ scale grows, and as agent productivity grows (the ordinary Compass agent generates 19% additional revenue in the next 12 months), Compass will be ready to make improvements to its profitability margins, which we have previously noticed in the firm’s latest effects.

Note as properly that Compass has guided to “at the very least breakeven” modified EBITDA this 12 months on a profits profile of $7.6-$8. billion (flat to last calendar year, in which the company generated $2 million of altered EBITDA), and that by 2025, the corporation is aiming to crank out $1.2 billion of modified EBITDA. We will take a look at the math driving this in the upcoming segment.

Meanwhile, at existing share prices in the vicinity of $5, Compass trades at a marketplace cap of just $2.33 billion. Soon after netting off the $475.9 million of money on Compass’ most recent stability sheet, the firm’s ensuing business value is $1.85 billion. This usually means Compass is buying and selling at a fraction of this year’s anticipated earnings, 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.

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.

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.

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.

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.