Zillow tumbles as analysts cut targets due to persisting challenges

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Zillow Group Inc. shares were poised to fall to a six-week low after its results and updated forecasts suggested its entire "portfolio is faltering" at a critical time for the company looking to pivot its business, analysts said.

The mixed second-quarter report was headlined by a miss in adjusted earnings before interest, taxes, depreciation and amortization as the online realty platform predicted home-flipping losses. Analysts across Wall Street trimmed their 12-month price targets on the weaker expectations at both the premier agent and homes businesses.

Shares of the company sank 15% to $42.20 in trading before the U.S. market opened on Aug. 8. The stock hadn't traded below $43 since June 26.

Here's what analysts are saying about the results:

Key challenges persist as "core IMT performance remains weak, Homes is burning cash at a rapid clip, and now Mortgages is experiencing serious issues … i.e., the entire Zillow portfolio is faltering," said Susquehanna analyst Shyam Patil.

The stock has typically garnered a premium because of secular runway and "supposedly 'strong competitive positioning,' but we see that changing," said Patil.

The second-quarter revenue beat, said Jason Deleeuw of Piper Jaffray, was driven by stronger Homes segment revenue though "profitability was impacted by cost of revenue moving to 97% of revenue versus 95% in the first quarter, primarily due to a valuation adjustment lower to home inventory greater than 60 days."

"We remain neutral on ZG as we believe the pace and profitability of the Zillow Offers ramp is highly uncertain as iBuying is still a new market segment with numerous competitors competing heavily on price," said Deleeuw, who sees a slower and more volatile Zillow Offers ramp limiting upside scenarios.

The second-quarter results reinforce Wedbush's Ygal Arounian's view that Zillow's current pivot has "plenty of bumps" and "is far from a straight path" to a larger market opportunity.

Weak results in most important core segment "seems unlikely to meaningfully improve through 2020 with a transition to Flex ahead and the associated execution risks," said Lloyd Walmsley of Deutsche Bank.

For Daniel Kurnos of Benchmark, "Homes, however, remained a bright spot, even if the increased success continues to drive incremental EBITDA losses." He still sees significant runway for Homes business which can more than offset near-term Flex disruption.

Zillow forecast that its new home-flipping business would lose as much as $80 million in the third quarter before interest, taxes, depreciation and amortization.

Overall, the home-search company is projecting third-quarter adjusted EBITDA between an $18 million loss and a $2 million gain. That compares to a consensus estimate of $17 million.

The company generated $249 million in second-quarter revenue from Zillow Offers, an algorithm-driven spin on home-flipping, and received requests from 70,000 consumers who wanted to sell their homes to Zillow over the internet.

Chief Executive Officer Rich Barton said in an interview that revenue growth from Zillow Offers shows that the business is working. "It's being driven by people who want an easy, convenient, hassle-free way to sell a home," he said. "We're far from being at what I would call scale. I'm confident that when we do get to scale we will be able to do 400 to 500 basis points of profit off this business." That margin would apply to each home Zillow buys and sells.

Going forward, Zillow will need to show that it can turn a profit in the capital intensive, low-margin business of flipping homes. Consumers are willing to sell their homes at a small discount in exchange for the speed and certainty of selling their home over the internet. When fees rise too far beyond what traditional brokers charge, sellers return to the old methods. Zillow reported a $56.5 million loss before interest, taxes, depreciation and amortization in its Homes segment, which includes Zillow Offers.

Zillow shares had increased by 45% since its last earnings report in May through the close of trading on Aug. 7, when the company's better-than-expected revenue from Zillow Offers highlighted the benefits to the company's ongoing transformation. Those results, combined with co-founder Barton's return to the CEO role, have gotten a lot of attention. Perhaps more importantly, real estate agents have stopped defecting from its advertising platform.

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