Douglas Elliman: When It Rains, It Pours (NYSE:DOUG)

Since my final update, Douglas Elliman (NYSE:DOUG) has continued to commerce down as the prevailing dwelling actual property market continues to wrestle from excessive mortgage charges. Nonetheless, with shares down one other 26% since August, the corporate is just price ~$150 million (Determine 1). Is it time to lastly flip bullish on the corporate’s shares?

Temporary Firm Overview

Douglas Elliman is a number one actual property brokerage firm centered on markets like New York (together with the NY suburbs), Massachusetts, Florida, California, Texas, and Colorado. DOUG has roughly 6,900 affiliated brokers throughout 120 U.S. places of work servicing its purchasers (Determine 2).

DOUG’s brokers primarily concentrate on the high-end luxurious phase of the market, with its brokers advising on $43 billion in transactions in 2022 or ~$6 million per agent. DOUG’s common transaction worth was $1.6 million, considerably greater than its friends (Determine 3).

Q3/2023 Was One other Weak Quarter

To no person’s shock, Douglas Elliman not too long ago reported one other weak quarter, with the corporate recording $239 million in revenues from advising on $9.3 billion in actual property transactions within the third quarter (Determine 4). This was an 8% decline YoY in comparison with $260 million within the prior 12 months’s third quarter when Gross Transaction Worth (“GTV”) was $10.2 billion in Q3/22.

Nonetheless, the corporate’s long-talked-about concentrate on prices appears to be lastly flowing by to the underside line, as DOUG reported an working lack of $8.8 million, not a lot decrease than the $5.2 million working loss in Q3/22, regardless of the big decline in topline revenues.

Price Cuts Lastly Taking Maintain

With respect to prices, actual property commissions clearly scaled down YoY from decrease transactions. Nonetheless, it was encouraging to see whole non-commission bills lower by $7.7 million YoY or 9.6% (word, my calculation is completely different from administration’s commentary which quotes $7.8 million and 10%).

In response to administration’s commentary on the Q3 earnings call, the decline was pushed by a discount in headcount by 60 staff price ~$3.6 million in bills, a $2.2 million discount in promoting and sponsorships, $1 million discount usually bills, and $400,000 discount in journey bills.

One among DOUG’s largest bills is occupancy, which quantities to $34 million / 12 months in lease bills plus ~$10 million in further prices. Between now and 2025, DOUG plans to consolidate places of work and let some leases expire the place it would not make sense to resume them. Administration believes there may be scope to avoid wasting a number of million {dollars} per 12 months in bills from this effort.

Resale Exercise Continues To Plumb Depths

Sadly, to this point, the resale market continues to be moribund with little indicators of life, as present dwelling gross sales not too long ago broke to new multi-year lows at a 3.79 million seasonally adjusted annual fee in October (Determine 5). This tempo of resale exercise is unprecedented and is even decrease than resale exercise in the course of the early days of the COVID pandemic.

This has prompted Larry Yun, the Nationwide Affiliation of Realtor’s (“NAR”) Chief Economist, to decrease his full-year forecast for resale exercise to 4.15 million for 2023. If 2023 resale exercise finally ends up at 4.15 million, this can be even slower than in 2009, in the course of the depths of the Nice Monetary Disaster (Determine 6).

When It Rains, It Pours

To place additional ache on realtors’ distress, the Nationwide Affiliation of Realtors and a number of other brokerages have been not too long ago ordered by a federal jury to pay $1.8 billion in damages to class motion plaintiffs who argued that they have been pressured to pay extreme charges to actual property brokers. The jury’s verdict additionally permits the court docket to problem treble damages, which might elevate potential damages to over $5 billion.

Whereas Douglas Elliman was circuitously named within the Sitzer/Burnett class motion lawsuit, the corporate has been named in two separate instances involving customary actual property enterprise practices and the Nationwide Affiliation of Realtors guidelines that have been the topic of the category motion lawsuit.

Moreover, other than the rapid financial damages from the lawsuit, the actual property brokerage enterprise is in full disarray as the prevailing enterprise mannequin could must endure excessive modifications within the coming years on account of this verdict.

For instance, below the prevailing mannequin, actual property sellers pay as much as 6% commissions, or $60,000 in commissions on a $1 million property, to each purchaser’s and vendor’s brokers. Nonetheless, below the court docket verdict, “the sellers would now not be required to pay their consumers’ brokers, and brokers could be free to set their very own fee charges”.

This might doubtlessly result in a worth battle the place brokerage commissions are completely lowered for all business members, together with Douglas Elliman. For context, DOUG generated $1.1 billion in commissions in 2022 from advising $43 billion in transactions or a 2.56% fee fee. Any discount in fee charges might have large ramifications for actual property brokerages’ valuations and DOUG traders might want to carefully monitor the authorized developments within the coming quarters.

Actual Property Growth Pipeline Could Lead To Sizeable Payoff In Coming Years

One fascinating facet of the Douglas Elliman story that’s not effectively lined is its publicity to the brand new building market. Going by the corporate’s stories and convention calls, we discover that Douglas Elliman has a nascent enterprise phase known as ‘Douglas Elliman Growth Advertising’ (“DEDM”) that gives experience in gross sales, leasing, and advertising for brand new improvement tasks in key markets like Florida and Texas.

In 2022, this phase generated $71 million in revenues and is on tempo to match or exceed that in 2023 (Determine 7).

On the Q3 convention name, administration famous that they presently have $21.5 billion within the improvement pipeline that ought to move by to the P&L within the coming years. Assuming new improvement fee charges are much like resale commissions, this could possibly be fairly a profitable complementary enterprise phase for Douglas Elliman.

Sadly, to this point, monetary figures for this enterprise phase are scant, so it’s troublesome for analysts to correctly worth this chance.

Up to date Mannequin Nonetheless Sees Losses

Determine 8 exhibits my up to date monetary mannequin following the newest lowered resale forecast from NAR and DOUG’s price cuts. General, monetary efficiency is predicted to be worse in 2023, primarily as revenues are actually projected to say no 15.5% YoY to $974 million, in line with a steep 17.5% decline in resale exercise projected by NAR. My working earnings estimate is lowered to -$53 million and I count on DOUG to report a $0.42 / share loss for the 12 months.

Even with a projected 13.5% YoY rebound in resale exercise in 2024 and decrease non-commission bills, I nonetheless count on DOUG to run an working lack of $18 million and a $0.09 / share loss.

Warming Up To DOUG’s Valuation

Nonetheless, with the corporate now buying and selling at a valuation of solely $156 million enterprise worth, the inventory is definitely beginning to look fascinating (Determine 9). DOUG’s present valuation is just implying EV / agent of $22,600.

As I famous in my prior article, Douglas Elliman could attraction to a different brokerage agency that may use the Douglas Elliman model to promote luxurious actual property. As a non-public firm, a possible acquirer could possibly reduce prices additional than what DOUG administration has completed to this point and may return the corporate to profitability.

Nonetheless, one obstacle to an M&A transaction is the overhang from the category motion lawsuit. Till the mud settles and business members get readability on the place fee charges will find yourself, I doubt anybody could be keen to tackle the danger of creating a bid on Douglas Elliman.

Conclusion

For now, I proceed to be cautious concerning the shares of Douglas Elliman because the resale market continues to endure from excessive mortgage charges. If business estimates are appropriate, 2023 could show to be the worst 12 months when it comes to present dwelling gross sales because the Nice Monetary Disaster.

Wanting ahead, there may be additionally an overhang on DOUG’s shares from the potential fallout of the Sitzer/Burnett class motion lawsuit. The federal jury’s verdict opens the door for brokers and brokerages to choose out of the NAR and the potential for fee charges to fall considerably within the coming years.

Balancing the negatives is DOUG’s valuation, which is beginning to look very low cost, at simply $156 million enterprise worth. A possible acquirer should buy DOUG and use the model as its luxurious actual property providing. Nonetheless, I don’t imagine any deal can be consummated till there may be extra readability on how fee charges will shake out within the coming years.

I preserve my maintain score.