No investor wants to touch Compass (NYSE: COMP) right now, and the reasons are easy to understand. It’s a growth stock that’s currently losing money, which is one of the worst places to be in during the volatile market of 2022. On top of that, it’s a real estate company – and with rising rates and continued tightening of stocks, all signs point to a slowdown in trading volumes, which may begin in the second half of this year.
But as usual, the market is taking a very short approach to this stock. When I step back from the short-term noise about Compass, I still see a company that has quickly rocketed to the top of the US real estate market in a relatively short number of years. It has become a household name for both home buyers and sellers and has managed to continue to gain market share at a time when more companies are turning to discount brokers like Redfin (RDFN ).
Since the start of the year, Compass shares have lost 40% of their value; from the highs above $17 Compass hit last August, the stock is down more than two-thirds.
Compass’ bullish thesis revisited
Given Compass stock’s steep decline over the past few months, despite fundamental performance continuing to hold up, I’m upgrading my view on the stock to strong buy. I’d recommend investors double down on that drop like I did, and while Compass may have a tough few months ahead as real estate activity potentially slows (although I’d say that fear is already priced in to its stock price ), it’s still well-positioned to be a long-term winner.
Here’s a full rundown of reasons to be bullish on Compass:
- Within a few years, Compass has become a dominant brokerage. Compass’s market share in US real estate transactions is growing rapidly to around 6%. Already deeply rooted in key coastal markets, Compass has more recently branched out into new office opportunities in the Midwest. There’s still room for further expansion: Even after new market activity this year, Compass is still reaching less than half of the US population.
- Tertiary income opportunities. Recently, Compass opened the door to new monetization opportunities, including creating its own securities company. This positioning helps Compass gain more wallet share from real estate transactions as a whole. Compass pointed out that the rates of attachment on these tertiary services are on the rise. Compass estimates its US TAM to be $240 billion, of which only $95 billion and the rest comes from adjacent services.
- Strong brand image. Compass has 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 distinction against other tech rivals like Redfin.
- Scalable platform. Compass’ main costs are R&D expenses to provide its technology platform to Compass agents, as well as sales and marketing costs related to advertising its brand to buyers/sellers and potential new agents. These costs are scalable: as Compass increases in scale and agent productivity increases (the average Compass agent generates 19% more sales in Year 2), Compass will be able to improve its profitability margins. , which we have already seen in the last results.
Also note that Compass has guided to “at least break-even” adjusted EBITDA this year on a revenue profile of $7.6-8.0 billion (stable from last year, in which the company generated $2 million in adjusted EBITDA), and that by 2025, the company aims to generate $1.2 billion in adjusted EBITDA. We will examine the calculations behind this in the next section.
Meanwhile, at the current stock price near $5, Compass trades at a market capitalization of just $2.33 billion. After offsetting $475.9 million in cash on Compass’s most recent balance sheet, the company’s earnings the enterprise value is $1.85 billion. This means Compass is trading at a fraction of this year’s expected revenue and
There is a huge opportunity here: don’t miss the opportunity as the whole market looks the other way.
The path to profitability lies in adjacent services
One of the biggest investor criticisms of Compass is that the company has effectively bought its growth. That is, admittedly, partly true: Compass gained huge market share so quickly because it took the approach of buying up existing brokerages and affixing the Compass logo to them. However, Compass’ argument for this strategy is that agent productivity increases over time (particularly as agents are integrated into the Compass platform and brand) and will drive profits. on its acquisitions over time.
In 2021, the company achieved break-even adjusted EBITDA margins. By 2025, the company aims to grow its revenue base by approximately 50% to approximately $12 billion and generate Adjusted EBITDA margins of approximately 10% on these revenues.
As can be seen in the chart above, the majority (450 basis points) of this adjusted EBITDA expansion from flat margins to around 10% is expected to come from improved deal economics. The expansion of its adjacent services is of particular importance to Compass’ strategy going forward; in other words, to offer title, escrow and mortgage services to the buy side of its transactions.
The table below illustrates the progression of these offers. Title and escrow alone can nearly double Compass’ net income per transaction, and mortgage offerings through the company’s new OriginPoint subsidiary can offer much more than that.
Note that these are relatively recent offers. OriginPoint launched its first mortgages just in the fourth quarter. 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. Currently, title and escrow services are only used on a mid-single-digit percentage of Compass’s buy-side transactions, indicating a huge opportunity for the company to continue selling this product with its officers.
Continued robust growth
And despite fears of a near-term housing market crash, we have yet to see any deterioration in Compass’s results.
In the first quarter, Compass increased its revenue at a steady pace 26% y/y rate to $1.4 billion, which is a first-quarter record for the company. The chart below also shows that Compass ended the first quarter with a 5.8% trailing year market share in US real estate, up 150 basis points year on year. In the first quarter alone, Compass’ market share was even higher at 6.1%, up 90 basis points from 5.2% in the first quarter of the previous year.
Agent productivity also remains incredibly high. Compass not only grows by adding more agents to its network, its agents also produce significantly more than the industry average. As shown in the table 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 industry agent.
Here are some helpful anecdotal comments from Compass’s outgoing CFO Kristen Ankerbrandt on how the company sees the real estate market shaping up for the rest of the year, during her prepared remarks on the earnings call. first trimester :
The first six weeks of the second quarter brought tougher times across all industries. These headwinds along with limited inventory contributed to a slower-than-expected start to the second quarter. As a result, our second quarter revenue outlook has been impacted, as you will see in our second quarter guidance.
But despite the uncertainty of the current macroeconomic environment, we still expect market growth in our markets in 2022 due to continued strong demand and historically low inventory driving up prices. House prices are expected to reverse their current upward trend and fall dramatically to turn market growth negative. We don’t think that will happen, especially as prices in our markets continue to rise.
Key points to remember
I remain focused on the long-term opportunity for Compass to continue to gain market share and drive significant margin expansion through improved agent productivity and cross-selling of adjacent services. The long-fragmented and localized real estate industry is moving towards national consolidation, and Compass has established itself as the leading national brand. Stay a long time here and buy the dip.