Compass: This Real Estate Titan Is Too Good Of A Steal To Pass On – Seeking Alpha

No investor wants to touch Compass (NYSE:COMP) right now, and the reasons for that are easy to understand. It’s a growth stock that is currently losing money, which is one of the worst spots to be in during the volatile 2022 market. On top of that, it’s a real estate company – and with rising rates and continued inventory tightness, all signs are pointing to a slowdown in transaction volumes, perhaps to begin in the back half of this year.

But as usual, the market is taking a very short-sighted approach to this stock. When I take a step back from the short-term noise on Compass, I still see a company that has quickly boosted itself to the top of the U.S. real estate market within a relatively short number of years. It has become a household brand name for both home buyers and sellers, and has managed to continue gaining market share in an era where more business is supposedly shifting to discount brokerages like Redfin (RDFN).

Year to date, shares of Compass have shed 40% of their value; versus highs above $17 that Compass notched last August, the stock is down by more than two-thirds.

The Compass bullish thesis revisited

Given the steep drop in Compass stock over the past few months, despite the fact that fundamental performance continues to hold up, I’m upgrading my view on the stock to strong buy. I recommend that investors double down on this dip as I have, and though Compass may have a rocky few months ahead as real estate activity potentially slows down (though I’d argue this fear is already baked into its stock price), it’s still well-positioned to be a long-term winner.

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

• Within a few years, Compass has become a dominant brokerage. Compass’ market share of U.S. real estate transactions is growing rapidly to ~6%. Already deeply embedded into major coastal markets, Compass is more recently pushing into new office opportunities in the Midwest. There’s still room for further expansion: Even after the new market activity this year, Compass is still penetrated into less than half of the U.S. population.
• Tertiary revenue opportunities. Recently, Compass has been opening the door to new monetization opportunities, including starting its own title company. This positioning helps Compass derive more wallet share from real estate transactions as a whole. Compass has commented that attach rates on these tertiary services are rising. Compass estimates its U.S. TAM is $240 billion, of which only $95 billion and the rest is coming from adjacent services.
• Strong branding. Compass built a brand around being a full-service, high-quality real estate brokerage, very similar in style and profile to competitors like Berkshire Hathaway Home Services or Sotheby’s. This gives the company a very strong distinguisher against other tech-first rivals like Redfin.
• Scalable platform. Compass’ primary costs lie in the R&D spend to deliver its technology platform for Compass agents, as well as the sales and marketing costs of advertising its brand to homebuyers/sellers and potential new agents. These costs are scalable: as Compass’ scale grows, and as agent productivity grows (the average Compass agent generates 19% more sales in the second year), Compass will be able to improve its profitability margins, which we have already seen in the company’s latest results.

Note as well that Compass has guided to “at least breakeven” adjusted EBITDA this year on a revenue profile of $7.6-$8.0 billion (flat to last year, in which the company generated $2 million of adjusted EBITDA), and that by 2025, the company is aiming to generate $1.2 billion of adjusted EBITDA. We’ll examine the math behind this in the next section.

Meanwhile, at current share prices near $5, Compass trades at a market cap of just $2.33 billion. After netting off the $475.9 million of cash on Compass’ most recent balance sheet, the company’s resulting enterprise value is $1.85 billion. This means 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.

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.