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CoStar Group Inc.: A Great Company That Currently Seems Out Of Reach (NASDAQ:CSGP)

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Via SeekingAlpha.com

Expensive pleasures will soon bring the richest person down.

– Stephen Richards

CoStar Group Inc. (CSGP) is the leading provider of information, analytics, and online marketplaces to the commercial real estate sector. Their service offering covers all commercial property types including office, retail, industrial, multifamily, commercial land, mixed-use, and hospitality. It operates through its five flagship brands – CoStar, LoopNet, Apartments.com, BizBuySell, and LandsofAmerica – which are all largely internet and mobile-based and not greatly affected by brick-and-mortar related headwinds which have cropped up in this era of social distancing.

The stock has been a great wealth compounder for investors over the years and has outperformed the S&P 500 since 2017. I will explain below why this has been a great asset for investors and why the company’s revenue and operating model is less immune to current risks in the commercial real estate sector. Notwithstanding these impressive qualities, I also highlight why I think it might be prudent to stay away until the stock corrects to more acceptable levels.

Source: Yahoo Finance

Sturdy revenue and visibility with an interesting counter-cyclical edge

I like CSGP’s consistent revenue model, which is somewhat immune to the vagaries of economic cycles. Firstly, do note that the company is the leader in this space, with the largest research department in the industry, a comprehensive commercial real estate database, leading online marketplaces for commercial real estate and apartment listings. It also provides more information, analytics, and marketing services than any of its competitors. From 2015 to 2020, revenue for CSGP had grown at a CAGR of 18%, with annual growth never dipping below 15%. Recently, while CSGP cut its full-year guidance, it stated that it would be looking to deliver 13% YoY revenue growth for Q2. At a time when key market participants portend that US GDP could fall by -40% in Q2, here’s a company guiding towards double-digit revenue growth for the same period. What’s the secret to this general variance, you ask?

Well, the company’s revenue streams are all largely subscription-based licenses that get renewed automatically with a term of at least 1 year (contract rates though may change during re-negotiations). What I also like is that CSGP charges a fixed monthly amount for its services rather than fees based on usage or number of clicks – this is where its revenue visibility mainly comes from.

Then, there are some segments of its revenue profile that may even be counter-cyclical. On the recent Q1 call, CSGP’s management mentioned that when the country was in lockdown mode, search activity on one of its digital brands, Apartments.com, was succeeding pre-outbreak levels and, incidentally, saw its second-best sales month ever in April.

Besides, it’s worth bearing in mind that despite the slowdown in consumer sentiment, commercial entities will still need to renew and resign their leases, and CSGP’s clients will continue to earn commissions. The broad commercial real estate industry will still also need services that help it find other investment opportunities, value properties, dispose of properties, analyze markets and also market vacancies. All these factors will continue to put the wind in the sails of CSGP’s revenue model.

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The company’s margins too are best-in-class, so even though you may not see sizeable benefits of any large volume increase in an economic boom (largely because of its subscription model), this steep margin structure ensures strong flow-through right to the bottom line and operating cash flow levels.

Source: Seeking Alpha

Debt-free and strong cash flow generation

The other impressive aspect of CSGP, which lends weight to their premium multiple, is its healthy balance sheet structure and exceptionally strong cash-generating profile. At a time when a lot of companies and countries the world over are taking the rap for being overleveraged, with debt-to-GDP% and net debt-to-EBITDA hitting stratospheric levels, here you have a high-growth company with no outstanding debt (Net cash of $921 million as of December 2019), and ever-growing cash flows (operating cash flows have grown at 35% CAGR, and FCF has grown at 32% CAGR from 2015-2020). Because CSGP margins are at an elite level and it doesn’t have any sizeable interest obligations and can keep working capital in control, a large part of operating profits gets converted into operating cash flow. This has seen the operating profit to operating cash flow conversion ratio (the per dollar operating profit that gets converted to operating cash flow) stay elevated at a rate greater than 1x.

2016

2017

2018

2019

Revenue (In $m)

837

965

1191

1400

Annual revenue growth %

18%

15%

23%

18%

Cash from operations (CFO) (In $m)

200.6

234.7

335.5

457.8

Annual CFO growth %

43%

17%

43%

36%

Operating profit (In $m)

144.9

173.8

278.1

363.5

Annual operating profit growth %

1160%

20%

60%

31%

Operating profit to Operating Cash Flow Conversion ratio (X)

1.38x

1.35x

1.21x

1.26x

Free Cash Flow (FCF) (In $m)

173.5

194.2

284

375.5

Annual FCF growth %

41%

12%

46%

32%

Source: Seeking Alpha, CSGP, Self-generated

Technical Analysis and Valuations

On the daily chart, CSGP stock is currently forming a triangle pattern. It has seen some good strength since the March 23rd lows, up c.34%, which is roughly on par with the S&P 500’s performance. This recent momentum has seen the stock bounce back up above its 50-, 100-, and 200-DMA. This is all very well, but it’s also important to consider that it’s very close to the right upper-hand side boundary resistance ($680-700) of the triangle pattern.

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Source: TradingView

Besides, if we look at things on the larger time frame, i.e., the monthly chart, we can see that levels about $680 have tended to form wicks, indicating strong supply pressure at those levels. Would you want to take a long position at these levels? I know I wouldn’t.

Source: TradingView

Based on the monthly chart, my reading of things would be that the $500-700 zone is an area where the stock is likely to see a lot of sideways movement, consolidating here for a while before a decisive move can be made on the upside. You want to be adding long positions at the $500-550 level and not at current levels.

CSGP has always traded at a premium multiple to the sector median, but the current % variance across every valuation metric – be it P/E, PEG, EV/EBITDA, EV/sales – is, quite frankly, bonkers! In times like these when one ought to be thrifty, I’m not sure a stock with such steep valuation credentials should be on your shopping list!

Source: Seeking Alpha

Insider selling over the last 12 months is another reason to lighten up on the stock; Chairman reduced stake last week

There’s good reason to believe I’m not the only one who thinks the risk-reward on the CSGP stock at current levels is sub-optimal. Key insiders too think it might be a good time to cash out. Last week, Chairman of CSGP, Michael Klein, sold 6.1% of his stake at $639 for $9.6 million. It’s worth noting that there has only been insider selling and no insider buying in the stock for the last 12 months. About 10 months ago, when the stock was trading at similar levels of around $630-ish, the CEO, Andrew Florance, sold significantly, for $15 million. When both your CEO and chairman are divesting their stake in the company at +$620 levels, and the stock is now at +$660 levels you want to tread cautiously.

Source: Simply Wall Street

Source: Simply Wall Street

Conclusion

CSGP has a reliable revenue and operating model that will help it cope relatively well in the face of general market weakness. The company also has the balance sheet to survive a downturn and pick up cheap operating assets if the opportunity does come up. That said, now is not the time to be loading up on pricey stocks like this, and hopefully, we will have better opportunities to revisit this.

Subscribers of the Lead-Lag Report will note that I expect another round of selling based on the same risk triggers I reference that went risk-off at the end of January. In fact, I had reiterated this point, during my recent interaction with MarketWatch, telling readers that I expect risk-off to return in two waves – first, in the bond space, and then, in stocks. Besides, when the smart money hasn’t really participated in the current rally, it only validates the feeling that something is amiss.

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The reason I bring all this up is, it’s important to remember that old investment adage which states that great companies don’t always make great investments. Considering that CSGP is up c.34% already from the March lows and likely running into key resistance points, it’s difficult to be gung-ho about significant upsides from current levels. Besides, valuations on all metrics are enormously steep. Given my current broad risk-off thesis for markets in general, I would advise investors to stay on the sidelines and wait for a correction towards support levels of $500-550 before considering an investment in an overbought and pricey asset such as CSGP. I am neutral on CSGP for now.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.




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