Stephen Brashear
Anybody can grow revenues.
The first line in Redfin’s press release was “Second quarter revenue was $607 million, an increase of 29% compared to the second quarter of 2021.” That came despite a slowing housing market. Pretty impressive, right?
Only if you believe that revenue growth surely leads eventually to earnings. But what if revenues are growing because the company is selling some of its products at a loss? For example, according to Redfin’s CEO in the company’s Q2 earnings call:
In the markets where we came back to advertising the 1% listing fee we charge our move-up customers, new Redfin listings in July grew ten points faster than the market overall…As we invest more in advertising this fee in 2023, we expect listing market share to accelerate.
Redfin’s real estate brokerage and mortgage products are commodities, very difficult to distinguish from the multitude of its competitors. During my career as a stock analyst following financial services stocks, I saw many rapidly growing companies whose growth came from giving up price or from taking too much risk. The frequent result was failure.
Redfin has been growing revenues and losing money for many years. Q2 was another example.
Redfin’s widespread Q2 losses.
The company now reports earnings separately for its four business units. Here’s how they did in Q2:
- Real estate services, Redfin’s core brokerage business. A $19 million loss, $10 million of which was severance expenses.
- Properties, Redfin’s “iBuying” or home flipping business. A $3 million loss.
- Rentals, Redfin’s recently acquired apartment leasing web site. A $19 million loss.
- Mortgage, Redfin’s mortgage origination business, again recently acquired. A $6 million loss.
Throw in another $28 million of unallocated overhead expenses and Redfin’s Q2 loss totaled $78 million. The first half of 2022 loss was $170 million. And first half operating cash flow, excluding inventory changes and including capital spending, was a $107 million loss. Another $97 million of the company’s cash went to those so far money-losing acquisitions.
OK, so the last two quarters were tough. But brighter days ahead, right? Wrong. The next two quarters will in my view be worse.
The near-term housing outlook is not bright, to say the least.
I am not a housing bear. As I noted in my recent article on mortgage insurer Radian, housing activity long-term is supported by (1) a housing shortage, (2) the decade-long high quality of mortgage originations, and (3) the likelihood of only a modest recession. But reality says that the next couple of years will be challenging because of affordability issues and a weak economy. Let’s see what some important industry players say about the near term:
The Mortgage Bankers Association expects home sales to decline by 8% this year and another 2% next year. And it expects mortgage originations to decline by 41% this year and another 5% next year.
Anywhere Real Estate (formerly Realogy) said in its Q2 earnings release that:
The Company now estimates Operating EBITDA for full year 2022 in the range of $600 to $700 million from $750 to $800 million but cautions that the macroeconomic environment continues to shift quickly. The reduction from prior estimates is predominantly attributable to declines in projected year-over-year home sale transaction volume in the range of (10)% to (20)% in the second half of 2022…
Rocket Mortgage said in its Q2 earnings release that it expects Q3 mortgage loan originations to decline by roughly 25% from Q2, and its gross profit margin to decline by about 10%. The company reported a Q2 loss of $0.03 a share, so Q3 should be a larger loss.
Redfin itself said that:
Total net loss [for Q3] is expected to be between $87 million and $79 million, compared to net loss of $19 million in the third quarter of 2021.
So Q3 is a likely washout. Then think about Q4, when home sales are seasonally slow; for example, Census Bureau data from 2002 to 2019 showed that new home sales in Q3 averaged 12% less than Q2, and Q4 sales fell another 12%.
Redfin’s cash challenge.
I calculate “net cash” for Redfin as the sum of:
- Cash and short-term investments
- Inventory of homes and mortgages for sale (will soon be cash)
- Short-term borrowings to help finance the inventory
- Long-term borrowings in the form of convertible senior notes
At the end of 2020, Redfin had $596 million in net cash. In 2021, after $328 million of negative cash flow and acquisitions, net cash fell to a negative $301 million. Now six months later, net cash is negative $520 million. By the end of this year I expect it to drop to about negative $700 million.
The Mortgage Bankers Association says that housing activity will decline a bit next year. Not a serious challenge for a well-capitalized company. But can Redfin maintain business as usual in that environment? I believe the answer very well could be “No.” I think serious cost cutting is almost certain. Restrictions on the properties business is possible. And most costly to shareholders, the company may have to issue more debt or even equity from a position of weakness.
This stock should go lower. A lot lower.
How to come up with a fair value for Redfin? I can’t do an earnings analysis because Redfin will be generating losses for the foreseeable future. Book value? It is less than $2 per share now and will drop below $0 some time next year, if Wall Street analysts’ estimates ($-2.68 this year and $-1.78 next year according to Seeking Alpha) are close to correct.
So why is the stock price currently $10? I believe because of a fervent hope that revenue growth will surely lead to earnings. That has been far from happening.
Where could I be wrong? In the short term of course, stocks can do the opposite of anyone’s expectation, for all sorts of reasons. Long-term, Redfin would have to generate some combination of permanent price increases and cost cuts. That is tough to do in a competitive industry, so I give this outcome a small chance of occurring.
I strongly suggest selling the stock.
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