Inflation has been the story of 2022. It has led to an aggressive campaign by the U.S. Federal Reserve to increase interest rates, often by 75 basis points at a time, which is triple the pace of the traditional 25 basis point move.
It's diminishing the spending power of consumers and crushing investor sentiment, which has resulted in a steep 28% decline in the Nasdaq-100 technology index year to date. The real estate sector has suffered particularly badly as rising interest rates tend to dampen house prices. Shares in large-scale brokerage company Redfin (RDFN 0.77%) have tumbled 95% from their all-time high as a result.
But there are signs inflation might have peaked around June, when the Consumer Price Index hit a 40-year high. It has stabilized and steadily declined since, which could be a major positive for companies like Redfin in the new year. Here's why investors might want to consider buying the stock now.
Redfin is cleaning up its business
Inflation still remains well above the Federal Reserve's target of 2%, and it could take several months for it to fall fast enough to entice investors back into high-flying technology stocks. But the Consumer Price Index is a lagging indicator, and several of the inputs that drove it higher are currently tumbling back toward pre-pandemic levels (used car prices and freight prices being two of the big contributors), so there is reason to be optimistic.
Nonetheless, Redfin has made some responsible moves to ensure the survival of its business during these tough times. The company has laid off 27% of its workforce this year, including 470 employees in June and another 862 earlier this month. That latter group came with the closure of its RedfinNow iBuying business.
iBuying (or direct buying) took off during the pandemic while home prices were soaring. It involves companies like Redfin purchasing properties directly from willing sellers and attempting to flip them quickly for a profit. In a market like this, where interest rates are briskly moving higher, it's a challenge to make that business model work. Redfin's chief competitor, Zillow Group, shuttered its iBuying business late last year after incurring hundreds of millions of dollars in losses.
The wind-down has already begun. Only 396 homes were purchased under the RedfinNow program in the third quarter (ended Sept. 30), which was a 45% drop compared to the same time last year. The company said it had $265 million worth of properties in its inventory as of Oct. 31, with $92 million under contract to sell. It believes the segment will be fully liquidated by the second quarter of 2023.
This could be a big positive for investors, because Redfin's third-quarter loss on the basis of adjusted earnings before interest, tax, depreciation, and amortization (EBITDA) was $51 million, but it was all attributable to RedfinNow. So theoretically, closing that business unit will improve the company's earnings potential.
Redfin's path forward looks positive
Once the iBuying business is wrapped up, Redfin will be able to focus on what it does best: real estate brokering. The company has an enormous presence in the U.S. reaching 96% of the population, even after the reduction in its workforce.
The company's success stems from its significant scale. Most real estate firms are small and focus on one geographic area, but Redfin has amassed a sales force of 2,293 lead agents, which allows the company to close a high volume of deals. As a result, it can charge a listing fee as low as 1% compared to the industry's typical 2.5% fee, and it has saved its customers over $1 billion to date.
Redfin's market share continues to climb steadily, and it now represents 0.8% of all homes sold in the U.S. That might not sound like a big number, but considering there are over 3 million people holding a real estate license across the country, Redfin is punching well above its weight.
Unfortunately, the tough economy has led to a slowdown in the housing market overall, meaning fewer listings and fewer sales. Redfin's revenue has suffered this year as a result, and its third-quarter figure of $600 million represented an 11% year-over-year drop. But more importantly, the company is on track for modest growth on an annual basis.
Why Redfin stock might be a buy now
Redfin isn't a profitable company at the moment. It has a net loss of $260 million during the first nine months of 2022. But given its recent cost reductions, plus the closure of loss-making RedfinNow, the bottom line should be significantly healthier even if the real estate market remains soft.
Investors might also be comforted by the company's balance sheet, which holds over $460 million in cash, equivalents, and short-term investments. It will also receive a windfall once the company has offloaded the remainder of its properties in inventory. So Redfin should have enough cash on hand to weather at least the next 12 to 18 months without requiring more capital.
In terms of valuation, Redfin stock is trading at rock bottom at the moment. After declining by 95% from its all-time high, the company is now worth just $560 million -- a fraction of the $2.2 billion in revenue it's likely to generate this year.
The short term won't be easy, but if inflation truly did peak in June, then Redfin is likely to catch a nice tailwind in 2023 as both consumer and investor confidence turn for the better. For that reason, the stock's risk-reward equation is quite attractive at current levels.
