Domain Holdings Australia: Is Growth Worth the Cost?

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What Happened to Domain Holdings?

Looking through stocks that hit 52-week lows yesterday, Domain Holdings Australia [ASX:DHG] stood out like a sore thumb.

That’s the same Domain group that spun off from Fairfax Media Ltd [ASX:FXJ]. The online property advertiser listed as a separate entity on 16 November. But for all its high hopes, the stock has traded down by a double-digit percentage.

domain group stock

Source: Google Finance

It is a tad strange that Domain hasn’t hit it out of the park since listing. The group follows the same model as realestate.com.au, owned by REA Group Ltd [ASX:REA].

REA Group is one of the standout winners this year. The stock has traded up almost 40%, with a market cap of more than $10 billion.

So why haven’t investors bought more of the stock?

Well, for one, Domain is outside the ASX 200. Before Domain listed, Fairfax shareholders automatically received Domain shares. For many large institutions, holding companies outside an index isn’t something they do.

For example, say a fund manager had a policy to only hold stocks listed on the ASX 200. After receiving Domain shares, they would have to sell as it’s outside the ASX 200.

It’s a dumb policy. Others might not want Domain, either. They signed up to own Fairfax shares, not Domain.

Domain’s Market Cap

At time of writing, Domain has a market cap of $1.9 billion. But I suspect investors might jump in as the business starts growing earnings in the near future.

The group generated $217 million in sales from their core digital business in 2017. This made up 68% of total sales ($320 million).

If REA Group is anything to go by, Domain should experience rapid growth. Over the past five years, REA Group has grown revenues at a compounded annual rate of 14.8%.

At the same time, the business has averaged a profit margin of approximately 35%. If Domain could do the same, the business could generate as much as $638 million in sales and $239 million in profits.

Are these estimates too optimistic? Maybe. But assuming Domain can grow sales by 10% in FY18 and maintain a profit margin of 25%, the group could report profits of $88 million.

In this scenario, the stock would be trading at 21.6-times FY18 earnings. Compared to REA Group, trading at almost 50-times FY17 earnings, that’d make Domain look like a steal.

However, paying more than 20-times earnings for any company that’s not the clear industry leader might be a step too far for many investors. I’d suggest you proceed with caution when looking at Domain Holdings Australia.

Cheers,

Härje Ronngard,

Junior Analyst, Money Morning

PS: Want to find stocks that could potentially run up 100% or more?  Check out what we believe to be the three best small-cap stocks trading on the ASX right now.

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