Zillow (Z) – Stock Valuation – How High Can This Stock Go?

Zillow (Z) – Stock Valuation – How High Can This Stock Go?

hello and welcome to rational investing my name is cameron stewart cfa thank you very much for watching the channel i greatly appreciate all the comments all the subscribers thank you very much this channel is dedicated to the rational investor the cash flow hungry investor and this week up is zillow we’re going to go through their most recent 10k that they filed december of 2020. we’re going to look at nine years of historical zillow financials we’re going to take a look at what we think that business generates in terms of cash flow and if we push that forward into the future years what do we think we can earn by buying the stock and holding the stock for a long term you’re ready let’s get to work [Music] in my hot little hands is zillow’s 2020 10k file as of their fiscal year end which is december now before we dive into this we’re going to do like we do on every stock we’re going to review the five key attributes and that would be top line revenue growth it’s got to have it zillow better be grown top line number two earnings growth we look at ebitda that’s enterprise level earnings ebitda better be growing for zillow number three is strong free cash flow i want to see strong free cash flow from this company it needs to have low debt which is less than three times debt deep dot needs to be well priced well priced on a enterprise value ebitda level it also has to be well priced such that it generates a return for us that is satisfactory for our own return on capital needs hopefully it beats the market you ready let’s dive into this zillow i highly suggest you print the 10k out you can find it on zillow’s website under investor relations or go to the sec search page and you can search any public filing screen for the 10k pull it up give it a read pull up a nice whiskey or something like that that you like this is a belvini 15 year delicious pull up whatever you like sit back and take take a read what you’re going to find is a very very interesting company let’s get right into it behind me is the opening letter to shareholders from rich barton the president co-founder and chief executive officer we summarizes the year basically this was released in the middle of the pandemic so the front part of it is him saying hey we’re in a pandemic fyi but below here it does give some details on the business so they saw a record of 9.6 billion dollar billion visits so i’m used to saying dollars billion visits to the zillow group’s website which is fantastic another a bunch of other um accolades and then the last one down at the bottom i wanted to bring you their attention to here we raised nearly 1 billion dollars last may in capital and i did want to point that out that that’s probably means dilution in our minds equity haulers if they’re raising capital some of it’s debt they did issue a convertible debt but they did also do a capital raise as well so i’d expect a little bit of dilution there on the stock price but feel free to read through it’s a fantastic read and let’s keep going so the very first section i would read of any 10k is obviously the overview comes up right away in part one i’m not going to go through everything here but there’s a couple things about their business and how they describe the business inside the document that you should know and you should always read first of all they do talk about their total addressable market here and they actually increase this significantly they’re now calling their total addressable market 2.2 trillion dollars it’s basically all the real estate transactions that happen in the united states in a given year that’s home price times number of homes sold throughout the entire united states they’re saying hey we play in this market this is the totally addressable market and we think we could get a piece of that now recognize one thing one the sale price of a home isn’t revenue to them right the sale price of a home they get a commission on so first off this 2.2 trillion is the gross value they’re going to be trying to both gain market share against that and then take a percentage small percentage of that of that dollar amount but it’s interesting it’s massive which is what something we like to see is something they can go after the next one down at the bottom here where they describe their segments of their business you need to read this because in the 10k they break out the financials based on these segments number one is the home but they buy they flip houses they buy them take them their balance sheet and then sell them that home is a segment of their p l we want to read that internet media and technology the imt bit that is uh rental agents or real estate agents paying to advertise on the on zillow it is a num a host of other rental new constructions dot loop i don’t know what that is display and other advertising that they do this is a big section for them for revenue and profit and the last one is mortgages they recently got in the mortgage business so we’re going to look at the financials keep in mind these three segments we’re going to figure out which ones are growing which ones are most profitable where they generate their cash flow okay the next page i want to bring you to before we dive into the actual financials and forecasting but i want to look at page 52 it’s 61 of the pdf it’s 52 in the actual document here’s where they break out their income statement based on the segments that we just discussed it’s very interesting to see which ones are truly delivering the cash flow that the business is based on because it might sound great to sell homes and flip homes but if you don’t make a lot of cash how good is it really and i think that’s what’s the big surprise for me is where they get their cash from actual pure hard earnings cash so this is a quarterly data this is home sales which is their top segment for december ending they made 300 million dollars from selling homes that they had purchased through their app the next one here is imt that’s that that internet marketing and technology they brought in 432 million dollars the biggest segment for their business and you can all cover growth and then mortgages call it 61 million dollars for a total revenue for that quarter of 788 million uh over time right they’re all growing so re home sales goes from 120 to 300 imt goes from basically 300 to 420 and then mortgages 27 to 7 to 61. so good growth in each of these these two home and imt are the largest now let’s go to cost of sales so you think of revenue what does it cost to generate that revenue we have two components of that right you go to your variable cost those are costs that directly relate to the product you’re selling you have operating costs which is like management rent what does it cost to maintain the organization they’re fixed generally like like a rent is fixed so what you want to do here is figure out where they’re generating their most of the cash flow and if they made four or three hundred million dollars from selling a home well the homes that they caught they had to buy them from someone they spent 277 million dollars buying the homes that they bought for that so if i subtract these two there’s not a lot of profit there in fact that’s a nine percent profit margin between these two in this segment it’s interesting here is the imt imt they made 423 million dollars in this one quarter and when it cost them it only cost them 27 28 million to generate 400 million of cash flow that’s a that’s a 94 profit margin here to here which is amazing and it means that most of their cash generated earnings are coming from this line item not the home sales flipping it’s nice because the homes has a big chunky number 300 million it’s great it pushes their earnings up excuse me it pushes the revenue up really really high but in terms of cash money that they’re generating that they can dividend that they can go buy other companies that they can pay you and i stockholders imt is where it’s at and it makes sense that advertising uh that’s agents paying zillow to be on their on their facility they don’t have to actually go do much for that the infrastructure the network is already established so i’d love to see this number continue to grow and as it does i would expect cash flow to grow commensurately the rest of it mortgages is basically the same that profit margin is 80 strong but how big can that get i’m not too sure the main stay here is the imt and then you’ve got your fixed cost down below very very stable or during this period of time both the uh the technology and the general admin basically constant sales as well so i think this operating level they’re kind of reached a plateau where they can grow that slowly over time but as revenue ticks up especially the imt they’re going to generate much more cash with that on a relatively fixed operating level which means most of that cash would follow the bottom line and i really really like that let’s take a look at their full year p l right now so top line revenue 3.3 billion dollars in 2020 prior year 2.7 prior to that 1.3 monster monster growth and top line revenue i expect to be able to check the box on that one here’s our cost of sales that we went through right there showing you what it costs to gen to generate the revenue up top again home sales revenue cost of homes very close thin margin imt 1.45 billion dollars of revenue they cost them 104 million that is crazy low that’s a huge huge cash machine good for them same thing with mortgages same thing so this this chunky number here for excuse me the so the difference between those two is their gross profit basically the profit that they generated by selling their their uh their wares or their services and and that number is mostly driven by the imt business you’ve got pretty stable costs down below year to year failure it is growing but not nearly as fast as revenue so i would expect operating margin to be growing over time the income statement to me is very clean let’s take a look at cash flow okay so here’s cash flow statement we’re going to pick up with the net income that’s the very first line always in cash flow statement we’re going to go down take a look they’ve got depreciation amortization here 110 million it’s not that big because the company’s a software company there’s not a lot of capital equipment that they’re buying so depreciation will be fairly low the big one here share based comp a lot of the ebitdas or earnings that i see on the market right now is the adjusted including in the zillow 10k they adjust and when they adjust they add back the the share based compensation for their employees which is an absolute no no that must be expensed because those employees are working and they expect to be paid in shares as part of their overall compensation package you cannot take that away so that is truly an expense don’t believe the adjusted ebitda that’s in the zillow book you need to expense the share based comp amortization impairments kind of go through overall that was pretty clean so we get down to an operating income a cash flow from operations 400 and 424 billion dollars it is positive excuse me this positive is negative the prior year positive from that so a little bit of growth hiccup but by and large it was a good number uh one more comment on this negative and twelve thousand dollars in op in cash from operations when i scroll up to see what the driver of that was you can see negative 673 million dollars in the inventory line when you see a negative inventory that means that’s cash out to go buy inventory that they’re going to turn around and sell in a later period that’s a good thing that means they’re growing so they have to invest in this case by buying homes that they turn around and flip for revenue so just because there’s a negative in this particular year in my book it doesn’t mean that they’re losing cash that is an investment into into inventory that they’re going to sell the next period in which they did and they generated record earnings and profit so i think i’m okay with that i’m okay with this patterning as well purchase property plant equipment is very very small 80 million dollars is really nothing and then of course you’ve got the cash flow from financing section down below where they’ve got a little bit of paying of debt they issued a convertible note uh and then they’re uh they’re borrowing they’re paying back some borrowing facilities and the proceeds from stock options that they have to what they have to fund overall it’s pretty clean they’re not paying a dividend so it’s not in there and the cash flow just come washing through the p l so let’s take a look at the forecast see we get before we get into the forecast let’s take a look at our nine years of historical financial on zillow and see what we get 2012 is the first year i could pull revenue data from 117 million dollars and then from there like an absolute juggernaut a beast it just continued relentlessly marching north fantastic seven hundred and seventeen hundred and nine 198 300 600 800 1 million and it just keeps going and they recently printed 3.3 billion dollars of top line revenue growth which is which is what i just showed you on their 10k that’s an absolute monster number it makes sense they’ve got a amazing platform the name zillow now is synonymous with real estate uh the tangible direct total addressable market is the entire uh u.s real estate market 2.2 trillion dollars so even if they get a fraction of that uh it’s going to be a really big number and they’re taking market share which is fantastic to see strong growth i put the annual growth rate of revenue off the site so you can see it’s strong double digits some case triple digits for the most part it’s in this 20 percent range which we’ll probably pick up when we forecast going forward ebitda right we want to see strong growing ebitda what does that look like well positive initially a little bit of weakness here i would imagine mainly because they’re growing right they’re on the operating leverage just yet but i was pleased to see that they’re holding their their their fixed cost relatively fixed and revenue scaling faster than than opex so they start to produce a profit and that profit gets bigger and bigger for a record ebitda 126 million dollars here’s the growth rate all over the place obviously because they’re growing a little bit but for the most part shockingly it’s strong it’s positive we’ve seen a lot of stocks in this channel that are growing top line and absolutely obliterating cash and earnings but these guys tend to be able to seem to be able to do it good for them let’s take a look at enterprise value uh and we’ll start that with debt so here i’ve got short-term and long-term debt they do have some debt 2.5 billion dollars worth of debt they even issued some new debt in 2021 calendar year 2021 uh but by and large when i look at the amount of cash they have relative to the debt they issued they can pay off most of that debt all in one go so i’m not too concerned with that even though this debt is significantly larger than the earnings they have cash to pay it off and earnings seem to be growing really quickly so i’m okay with that and when i look at it on a multiple basis over here net debt to ebitda they’re at 2.4 currently and that seems fine to me market cap market cap is shares outstanding times price i get market cap i add up the debt with the market and i subtract the cash and i get enterprise value enterprise value is the entire value of the company this is a great example think of the home that you’re buying on zillow the the sale price of the home is the enterprise value of the home if you then go to the bank and say hey i can’t afford to pay cash with an entire home i need a mortgage the bank’s like okay here is what 70 of the value of the home that’s debt that’s it’s over here if this number is fixed and i take this minus the debt what’s left is the equity so it would be 30 equity in this instance 70 percent debt in my little example but the market value home never changed same thing with business the market value of a home is the enterprise value how management decides to to carry the balance sheet and finance that business if they choose to hold debt it lowers the equity value of the of the company so just keep that in mind that’s why we look at enterprise value that’s the true value uh divided by ebitda why do i do that ebitda is a is a is a proxy for cash is poor one but we’ll get to cash in a second but it’s a it’s a solid earnings number at the enterprise over the entire business we don’t want to look at earnings per share because as a cfo and professionally i can manipulate eps by buying back stock reducing the number of shares outstanding means eps goes up even if i haven’t generated any higher net income for the business i’ve covered that in other episodes in the past go check those out but that’s why we look at an ebitda it’s a proxy for cash but it’s higher up on the p l and represents the entire earnings of the business so if i look at the entire value of the business and i look at the entire earnings of the business and i divide the two i get a payback ratio or a holding period how many years do i have to hold this stock for the the business to generate enough earnings to essentially buy itself and you can see 232 years is a monster monster number i think that’s probably the highest number we’ve looked at in this channel potentially and and why are people paying such a high value well it’s because they believe earnings will grow really really quickly okay so that’s why this number looks out of whack if you try to do like a a standard dcf or like a value investor kind of approach um they’re going to shy away from that number but realistically any company could be value it’s a matter of what is the value going forward and we’re going to forecast the business to figure that out okay next let’s take a look free cash flow we need to make sure that free cash flow strong to check that box okay behind me is free cash flow free cash flow from operations we covered this number earlier in the annual financials when i showed you the annual financials we’ve got 36 million dollars in 2012. it’s positive and it’s growing with earnings which i like i i very much like that i even like that this is negative when ibada was negative which means they’re expensing costs that need to be expensed properly i really really dig that but by and large this number is moving north with revenue it’s fantastic i’m going to take a little sip of my scotch just to say how fantastic that number is next the next thing what i love about software businesses is the capex is tiny remember capex is the property plant and equipment that they have to buy and reinvest in the business in order to keep the cash flow running and they’ve already built it they built this system and the the the tech developers the r d it’s all expense in the p l so once you get through the p l there’s no additional costs or very little that they have to expense in the in cash so that what happens is ebitda ends up being very close to cash flow operations cash flow in operations ends up being very close to free cash flow because this number is very very low and i like that so that’s about what two percent twenty excuse me twenty 20 of um actual free cash flow they keep a lot of it right and then what happens you got some debt here they made some debt issuance so that’s a positive number because they brought cash into the business via debt when i add these things up i get my free cash flow to the equity holders and this is what the business is actually valued on what’s it’s the future estimate of these numbers present valued to the current day is the actual enterprise value of the business or the estimate of it but in this particular year they made 700 million dollars in free cash flow when i look at this number 190 300 478 700 that’s growing it’s strong i like what i’m saying i really really do even if i take out the debt right because you can’t grow debt forever and i said well just give me free cash flow minus capex that’s still positive that’s still growing remember this number here was was was negative because they invested in inventory which they sold next year that’s acceptable so i like that if we keep going you get the number of shares that they have outstanding 224 million shares i’m saying i use the fully diluted number this time because they’ve they’ve issued some convertible bonds and i want to make sure those convert into stock and i count that dilution but you can see they’ve been diluting the company about about 11 per year over that period of time most of this is really in the historical periods prior to going public once they’re going public i think the resolution is going to moderate because they’re generating cash with the exception of this covid mishap where they did take some debt in they did stock issuance just to bolster the balance sheet besides that i think they’re not going to have to issue too much cash unless they really really want to try and grow so i take free cash flow divided by share to get free cash flow share strong growing excellent share price and i get a yield yield low single digits i think that’s um appropriate for a growth stock such as a zillow in fact five percent that’s five percent high because of the um the the one one time borrowing but overall i think a low single digit number like a two and a half 2.4 is an appropriate free cash flow yield for a stock that’s growing in the 20 range okay let’s forecast this business figure out what we’re going to do and the very first thing i want to do before i forecast it and i want to look at the real estate value itself they just they’re they’re touting this tam the tangible total addressable market 2.2 trillion dollars let’s take a look at some data okay behind me is data that i pulled from zillow you can you can get this data on their website this is total real estate sales i i use the they don’t they don’t give the total value they give you the number of homes sold and they give the average value of the home i simply took it down monthly up here this is their data but i organize it so you can see it so this is in what’s that may of may of 29 2009 they sold 200 or not they but the u.s market sold 200 000 homes in the month at an average price of a hundred and seventy seventeen thousand dollars each home uh that would mean these are in millions that’s a 13 uh billion dollar uh value yeah 13 35 billion dollars in real estate transactions happen in that particular month and all i do is sum up the month to get the annual number the annual numbers right here and i and i stretch it out to 2020 i get 2.1 it’s gonna be 1.2 trillion dollars of real estate value so it’s a little light of what they’re touting 2.2 maybe their data is it’s a little broader but i think this is encompasses a big piece of the overall real estate market and what i looked at over time you can see the chart behind me starting here i really wanted to see what happened in the last real estate decline what did the real estate market look like because it obviously looks good after that as it’s been growing both the number of units sold number homes and the average price is higher but what happens in the downturn because it can downturn it can go go down for multiple years this is four years of a declining market right here’s our growth rate eleven percent zero negative four this is this is rough times for the real estate market and real estate is a sick local business it will turn over again and you have what is this uh eight years of almost double-digit growth in the real estate market i think that’s fueled by low interest rates cheap money and if that does turn um over you’re going to see a real estate pullback so we need to keep that in mind that the real estate market can contract when we’re looking at zillow and forecasting now the good thing is i think that their economies of scale and their network is actually going to allow them to take market share as the market continues to grow or even if it shrinks because in a down market people might be looking to cut costs they might cut out an agent or go to a digital platform that saves them money so they can maximize the value of their home so even though this data seems to me like it’s decelerating going down double digit year-over-year growth 15 10 and then single digit growth year over year here at the tail end that to me seems growth is decelerating in the real estate market but i would give uh say that the market’s big enough to look continue to take market share and continue to grow okay now let’s take a look at our forecast so what i’m doing is i’m going to pick up revenue here 3.3 billion dollars i’m going to take this 22 annual growth rate and i’m going to string that forward and grow revenue over time so i’ll take the 22 growth and i’m going to reduce the growth rate annually of revenue as they get bigger and take market share so i’ll take revenue up to 4 billion which by the way this is being filmed as of august i looked at their current run rate for the last three quarters of uh their filings and they’re on they’re probably going to be above this number and beat this number so it’s it’s a good check so they’re going to continue to grow and that puts them at 16 billion dollars of top land revenue in 10 years now their current ebitda margin is 3.8 uh last year and so i’m doing keeping that and i’m going to grow their margin slightly over time to 10 even though the most of their money is coming from that imt which is really really wide march and stuff they’re going to continue to flip homes and that’s going to be a thin market as they grow they can probably gain market share by by getting even thinner and more efficient so i don’t think this is a huge margin business it’s a volume business and that’s okay so this is a ten percent ebitda margin on 16 billion dollars top line revenue gives me an ebitda estimate of 1.6 billion dollars out 10 years from now okay let’s plug it in so ebitda starts at 154 million dollars and grows to 1.6 billion over that time frame i’m giving it 25 handle why a software company low capex higher cash flow higher multiple b growing strongly we’re still in solid double digit territory uh on the growth perspective at at this time and see that market is still huge even after they’ve grown for a decade so i’m still going to give it a pretty curly number i know that’s high but it’s not a cheap stock i don’t expect it to ever really be a cheap stock so i’m going to leave it at 25 25 x that means that means i’m at a 41 billion dollar enterprise value less some debt plus some cash puts it basically 40 billion dollars of market value divided by fully diluted shares outstanding i get a 175 price target for zillow out 10 years now if i apply the same logic towards a free cash flow now what i can’t do is take the current free cash flow because that free cash flow doesn’t scale well as revenue scales they’re gonna they would generate more free cash flow in the future time so what i’m gonna do is i’m gonna peg it to ebitda and i’ll say we looked at cash flow operations and we said there’s very little capex there’s very little debt so what you generate in earnings most of it is going to pass through the cash flow from operations most of the cash flow operations are going to pass through to free cash flow so what i’m doing here is i’m taking 75 percent of ebitda and i’m saying they’re going to peel off 25 for capex they’re not going to borrow much so most of it’s going to go right through to the free cash flow to equity and it’s going to drop down divide by the shares and i get a dollar 20. i left this zero because next couple years they’re not going to kick out a dividend anytime soon for a little bit to be a little conservative i just gave it a zero number it doesn’t mean they don’t generate the cash flow i’m just saying i’m not going to count it in our discount or cash flow so one dollar and we go to five dollars and for 53 cents out 10 years i apply the current yield on it which is 2.4 which i thought was a reasonable yield for business that’s growing we’ve seen yields like this in the past for google or microsoft or so on and so forth and i get a 230 dollar price target out 10 years so two different values wildly different values one based on free cash flow or an assumption free cash flow one based on assumption of ebitda so now now that we have a price estimate we’ve got actually two two hundred and thirty dollars and 175 on a split the difference and call it about 200 of value i think this company is worth in 10 years now now that we’ve formed an opinion on what we’re willing to pay for the stock out in 10 years now let’s go look at what the stock price is and plug that into our irr don’t look at the stock price before you do this analysis do the analysis then look at the stock price so you’re not in you’re not unduly influenced by what you’re seeing in the market because the market is frequently wrong so let’s pop this into our irr calculation i’ve got 96 dollars what i pay in for the stock right now i’ve got a couple zero years to be conservative but they do make cash flow and then i get some free cash flow that’s starting to be earning and represented to my my stock either as a dividend or just cash that they can go use to acquire buy back stock i’m out at 203 dollars a share that has a ten percent irr product which is a market return and if i look internal total return i get two and a half times my money over that time frame if i were to do a distribution chart so i’m filming this now roughly august of 2021 stocks will move up and down who knows what’s gonna happen right well you can come back and watch this video and say okay well he did it it was 96 dollars what happens if the price moves but we keep the same forecast the same as the stock price moves the return falls unless you can up the uh the earnings of the forecast if the stock comes down the return goes up nicely so if there is some sort of dip in the real estate market or there’s some dip in the stock market this is definitely one to put on your radar to buy on the dip i think it’s fairly valued for where it is right now and i’m trying to figure out what to give it let’s review our five key attributes number one top line revenue growth absolutely 20 fantastic ebitda growth yes very strong growing fast free cash flow yes their software company with network leveraging i like it there’s very little capex strong free cash flow low debt yes less than three times and well price yes it is it is yielding a 10 return which is market it’s not my hurdle i need more than that on my portfolio but it’s definitely something that is there i’m gonna give it a good because it meets all five factors it is a market return i would absolutely love it anywhere in here preferably in here is really where i’d want it and i would watch it because you never know sometimes the market melts down and things like this come on sale so i would definitely put this on your shelf put this on your radar if you see it dip for whatever reason it should be a great time to step in or get in now if you want a market return out for a decade i think when i look at a risk return profile here the the risk is there is downside but i think the downside is limited because the real estate market is around even if it declines the real estate market these guys i think will continue to gain share because of their economies of scale because they can underprice the competition but if it can if real estate market continues to grow there’s upside they can add services and get a higher forecast than this and grow so i think risk return upside here is more than downside that’s why i picked the good even though the market is scheduled to be returned okay my name is cameron stewart this is rational investing if you like this channel you like what i do please hit that like button hit the subscribe you can also look at a course that i do teach at cashflow investingpro.com that course i will give you this excel template i’ll teach you how to read a 10k such as these how to calculate ebitda where to get free cash flow to operating leverage and everything so you can populate this template and be able to forecast for yourself because there are thousands literally three thousand plus stocks trading in the us currently can’t possibly cover all of them my objective is to teach you how to do it so you can go do it for yourself once again my name is cameron stewart c uh cfa this is rational investing thank you very much for your time i greatly appreciate it let me know what you want to see down below there’s a lot of great comments a lot of great stocks zillow was one that had been talked about for a while and people really wanted to see i’m very excited very happy i did it let me know what else you’d like to see i’m happy to take the recommendations thank you very much bye
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Zillow (Z) - Stock Valuation - How High Can This Stock Go?

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