The ASX 200 stock to own heading into the RBA rate cut cycle

Morgan Stanley says REA Group's (ASX: REA) proven ability to achieve double-digit annual price/yield increases will be supercharged by the RBA rate-cut cycle.

Morgan Stanley initiated coverage on REA Group with an "Overweight" rating and $250 target price. The stock closed at $217.92 on Friday, 11 October.

"History says a shift to lower borrowing costs, provided consumers still have job security, can be a catalyst to boost real estate turnover/listings growth," Morgan Stanley analyst Andrew McLeod wrote in a note to clients. The Overweight thesis explored three key points, which we will delve into below.

#1 The listings cycle

Activity levels in the Australian residential real estate markets is currently mid-cycle, according to Morgan Stanley. They're well-above pandemic lows but still below long-term averages. The key data points the analysts noted include:

• Since 2000, an average of 5.5% of housing stock has been "listed" for sale

• During Covid lockdowns fell to a low of 3.3% in the June quarter 2020

• In the December quarter 2021, this had recovered to a post-GFC peak of 6.2%

• Turnover is now 4.7% as of September quarter 2024

Where to from here: "Total housing turnover of 4.7% is still below the long run average of 5.5%. We understand that stamp duty costs mean listing volumes will likely be structurally lower than history, but we show that we have not reached long run average turn-over levels yet despite elevated activity in FY24."

#2 Pick your own listings cycle

Morgan Stanley's base case scenario for REA in FY25 includes:

• Listings growth of 3.0%

• Price/yield increase of 11% for core Australian residential business

• EBITDA growth of 16% to $959 million

• EPS growth of 24 to 447 cents

It's worth noting that these forecasts have not factored in any benefit from RBA rate cuts.

"Over the next 12-18 months, we anticipate additional volatility in the Australian listings environment, mainly due to uncertainty about the timing and magnitude of potential RBA cash rate changes," the analysts said.

Their macro team expect to see three rate cuts next year, starting in May 2025, however, acknowledge that there are a wide range of different expectations for rate cuts across the market.

Morgan Stanley has constructed a number of different earnings scenarios, subject to Australia's national listings volume growth and REA's price/yield increases.

If Australian listings growth turns out to be stronger than expected, at 8%, this would result in FY25 EBITDA of $1.02 billion or a 7% increase from the base case.

Source: Morgan Stanley Research

The analysts also illustrate a range of share price outcomes, based on the different EBITDA outcomes above and a range of different EBITDA multiples applied.

Source: Morgan Stanley Research

#3 Will RBA rate cuts drive higher listings?

Their short answer is: "Yes, we believe RBA will rates will add a boost to transaction volumes."

"History says when borrowing costs start to trend lower, provided consumers still feel confident about the economic growth and job security, then residential real estate activity levels will increase," said the analysts.

The charts below highlight the correlation between rate cuts and a spike in listings and real estate turnover in Australia over the past three decades.

Source: Morgan Stanley Research

Overall, REA is currently trading near its all-time high, with a 12-month forward price-to-earnings (PE) ratio of 45.2 — more than double its historical average of 20.6. While this valuation may seem steep, the company stands poised to benefit from a potential surge in real estate market activity. An uptick in property turnover and listings could serve as a significant catalyst for REA's financial performance.