Zillow Inc. (NASDAQ:Z) announced its Q4 2013 earnings report on Feb 12 after market close. The company reported a solid quarterly performance with all the business indicators showing a positive movement. However what is concerning is the extremely premium valuations the stock is currently trading at. A first look at the valuations: Zillow has a current market cap in excess of $3.5 billion for annual revenue less than 200 million (in 2013). A stock price of $90 and annual earnings…oh sorry, loss per share of 35 cents. Ridiculous indeed!! Let's take a detailed look at the company’s Q4 numbers and see why we think there might be a correction headed our way.
Zillow Q4 2014 financial performance
Zillow registered a Y/Y revenue growth of 70% in Q4 2013 compared to 72.6% in Q4 2012. The table below displays the company’s revenue growth and earnings over the last two years.
The company has grown at a phenomenal rate of 69% in 2013 against 77% in 2012. While we do call that a huge rate of growth, one fact remains clear; the growth rate is slowing down steadily but surely, with each passing year. Obviously, maintaining such a high rate of growth gets tougher and tougher as the revenue base gets bigger and bigger.
Another important question would be; what is the potential user base and potential for growth in unique users? The company ended Q4 2013 with 54 million average monthly unique visitors, a Y/Y growth of 57%. Let’s take a look at the Y/Y growth rate in number of unique visitors in comparison to the revenue growth over the last few quarters.
According to realtor.org, the number of houses sold (US) in 2013 was 5.09 million. Zillow’s monthly unique users at the end of 2013 was 54 million which raises an obvious question as to how many users actually bring value to Zillow in terms of people actually looking to buy/rent a home. The conclusion is plain and simple, going forward, growth rate of 40% in monthly unique visitors is highly impossible in the US market.
Let’s now look at Zillow’s profits in relation to revenues.
|Q4 2012||Q4 2013||YoY Change|
|Adjusted EBITDA Margin||19.9%||26.1%||6.2%|
|Net Income Margin||1.6%||4.7%||3.0%|
Zillow saw margin expansion at the operating as well as net level on a Y/Y basis. The operating margins increased by 64% Y/Y with significant increase in sales & marketing expenses (72% Y/Y), technology and development expenses (61% Y/Y) and General and administrative expenses (67% Y/Y). The adjusted EBITDA margin expansion of 6.2% was a huge positive from the quarter.
Moving on to Cash analysis, the company saw a 12% Y/Y decline in cash from operations for FY 2013, mainly on account of net loss of $12 million in 2013 compared to net profit of $5 million in 2012. The consequential impact on free cash flow was huge, with free cash flow margin for 2013 at 4.7% compared to 16.8% in 2012. The cash and cash equivalents balance at the end of 2013, at $437 million was healthy at 2x the FY 2013 operating expenses.
Actual v/s estimates
The quarterly performance came ahead of analyst expectations with the quarterly earnings of 19 cents per share beating the analyst consensus by 12 cents and the revenue of $58.3 million beating the analyst consensus estimate by 4%.
Though the quarterly performance was great considering the growth and improved operating efficiency, we believe that a P/S of close to 17 makes the stock very expensive. Add in the fact that the company is yet to establish stability in terms of profits and Zillow stock becomes an extreme risk at its current valuations. While we do not deny the great potential ahead, making a case for a bull run from the current prices would be a high risk bet. We believe the stock price has climbed far ahead of fundamentals and probably there are only two ways the pricing can be set right: Either the earnings grow at an extraordinary rate (from losses to profits in excess of 100 million, which currently seems almost impossible); or the stock price falls significantly (which we think is more likely). We would stay away from something as risky as the red-hot Zillow rather than burn our fingers. You want to take a look at stocks with better risk/return profiles? Then do check out our top stocks, as we love growing companies with proven profitability and cash flow abilities.
Do you agree or disagree with our evaluation and outlook of Zillow? Feel free to add your comments below.
To see Zillow’s latest stock price movement, click here (NASDAQ:Z)