Out of the blue
Shares in listed real estate agent McGrath (ASX:MEA) have had a tumultuous few years since listing in 2015, with a cooling property market and a depressed level of listings having been a key theme.
Our view in mid-2016 was that an inflection point was at hand has proven wide of the mark, as industry headwinds deepened, and with sentiment disturbed by a string of high profile departures in the agent team, and senior management.
Founder and Chairman John McGrath has also had his own issues to deal with, but has remained resolute that the company is in good shape, and as best positioned as any brand-wise to withstand current headwinds. Recent news that agents from competitor and industry disruptor Purplebricks are ‘leaving in droves’ also highlights that the grass isn’t always greener on the other side.
Investor appetite has also received a welcome lift with McGrath announcing last week that property developer Aqualand is taking a 15% stake, and engaging in a strategic relationship. This will make the Chinese based company the second largest shareholder behind John McGrath. The share placement is in two tranches, with the initial one (an 8.7% stake) completed and the second (6.3% stake) subject to shareholder approval. The agreed price of 42.5 cents per share is at a 25% premium to McGrath’s closing price previous to the announcement. Aqualand is entitled to appoint a director to the McGrath Board.
Source: McGrath Limited (ASX:MEA) Company Presentation
The deal will bring with it some material synergies, with McGrath (ASX:MEA) having the first right to discuss being agent for Aqualand’s new projects in the coming years, or provide property management services. The agreement has an initial 5-year term.
Aqualand has a portfolio of 18 sites, with a collective gross development value of A$5 billion. Outside Australia, the company has even greater punching power. Aqualand’s parent company is the Shenglong Group which has over $20 billion of assets across Asia, America, and Europe. In Australia the company targets mixed-use sustainable communities. In the project pipeline is a $2.6 billion development at Barangaroo (approval pending) in Sydney.
Image Source: McGrath Limited (ASX:MEA) Company Presentation
We believe the deal is a constructive step in McGrath’s turnaround program as it looks to combat a number of industry headwinds, and restore investor faith. We support the investment by Aqualand, and this should finally quash speculation which has abounded that John McGrath is looking to take the company private.
It is also welcome after what has been another turbulent year thus far. In tandem with a downgrade to earnings guidance in January, McGrath announced ‘significant changes to the Board and executive team.’ CEO Cameron Judson, Chairman Cass O’Connor, and other directors resigned en masse, with a pending transition to John McGrath as interim executive Chairman.
The departures have largely been painted as part of Stage Two of the company’s structural review, examining costs in non-customer facing roles. There was clearly an element of ‘right-sizing’ and a silver lining in our view has been the re-appointment of Geoff Lucas as CEO in late February. He formed a key part in building up McGrath from 2008 through to 2016, and will likely drive the recruitment of high quality franchisees and agents into the company’s network.
Two new non-exec independent directors have also been appointed since in Messrs Andrew Robinson and Peter Lewis, with the latter taking over as Non-Executive Chairman.
An initial point of business for the new CEO was some ‘kitchen sinking’ and realignment of profit expectations. On cue, in mid-March the company announced that based on the run rate at the time it expected underlying EBITDA for the financial year to 30 June to come in at $1.0 to $1.5 million. This followed one-off cash costs relating to the restructure and rationalisation efforts.
The guidance reset also followed an underwhelming half year result.
Statutory
EBITDA halved to a loss of $0.1 million, on revenues which fell 23% to $51.6 million. A 34% decline in company owned listings told the story, as did a 73 head fall in agent numbers to 583. A statutory net loss after tax of $25.5 million included goodwill impairments of $22.9 million. No interim dividend was declared.
Source: McGrath Limited (ASX:MEA) Company Presentation
More positively, the company maintained national market share at 3%. The balance sheet also remains solid, with no bank debt and $3.4 million in cash at 31 December 2017.
Turning to the charts, and on the daily chart, at the November low of $0.45 this failed to hold. More positively, there has been a move upwards from record lows following the announcement regarding the strategic investor. Prices have also moved back above the 50 day moving average. Overall, and in order for the short-term technical outlook to strengthen, a sustained break above the 200-day moving average (green line) of $0.61 is required. If this was to occur, then this would shift momentum back in favour of the bull-camp.
With reference to the monthly chart, the breach of support at $0.45 added to the bearish picture. The challenge now is for prices to reclaim this mark. This would then bring back into play a ‘bullish doji’ candlestick formation at $0.61 (as shown by the horizontal dashed-red line). Should this favourable scenario unfold, then a lift in medium-term positive sentiment is likely to follow towards resistance situated between $0.77 and $0.87. This is made up of the 38.2% and 50% Fibonacci retracement levels as represented by the thin-red set of retracements respectively. However, it should be noted that the long-term downtrend remains in play, and therefore gains are likely to be slow in coming.
Summary
McGrath (ASX:MEA) has been through the mill but the tough decisions that needed to be taken have been. Costs have been stripped out which will deliver annualised savings of $5 million and a leaner organisational structure. While possessing a strong brand in the Australian real estate market, the key variable though remains just when listings will improve significantly. We believe that this will now likely be in tandem with vendors generally resetting price expectations in line with a cooling property market and with higher lending rates coming through the system.
We also regard the investment by Aqualand positively. The deal will bring with it some material synergies, with McGrath (ASX:MEA) having the first right to discuss being agent for Aqualand’s new projects in the coming years, or provide property management services.
McGrath (ASX:MEA) will remain held in the Fat Prophets Portfolio.
