Zillow Moves On From iBuying

In this podcast, Motley Fool senior analyst Jim Mueller discusses:

• How Zillow is (in some ways) at a fresh starting point.
• The growing skepticism around iBuying as a profitable business.
• One thing to watch in Redfin's report.
  

Motley Fool producer Ricky Mulvey and Motley Fool analyst Sanmeet Deo discuss companies that are flying under Wall Street's radar, in part because of where they're located. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 16, 2023.

Chris Hill: We've got two things in the spotlight today, housing and the middle of the United States. Motley Fool Money starts now. I'm Chris Hill, joining me today Motley Fool Senior Analyst Jim Mueller. Thanks for being here.

Jim Mueller: Thanks for having me, Chris.

Chris Hill: Zillow shareholders got some good news. Fourth-quarter results were better than expected and shares of Zillow up a little bit today. CEO Rich Barton acknowledged the obvious, which is that the housing market was difficult last year, but that they got through it. They're focused on the future. Nothing particularly revolutionary from the CEO, but I understand why he said the things he said.

Jim Mueller: Definitely, so at the end of 2021, they announced that they're getting out of their iBuying business and that was their big thing. They were the iBuyers. They discovered that their algorithm wasn't working too well, was telling them this is a good price and they turned out not to be good prices to buy at. They got out and spent last year reinventing themselves basically, for the numbers, revenue was down. These are full-year numbers. Revenue down 8% to $1.96 billion for the year. Gross margin was down about 4 percentage points to 81%. Operating expenses were up 7.3%, led by general and administration and technology development expenses, both up 18 to 19, 20 percent or so.

That means an operating loss versus a gain in 2021 and a net loss versus a gain in 2021. If you back out that loss they had on iBuying. What an interesting comment, they really got rid of iBuying. They started 2022 with 10,000 homes in their inventory, about $3.9 billion worth. They ended the year with zero. They got rid of all those houses. Good for them. They brought in a huge chunk of change on the cash flow statement about $3.9 billion. Pretty close to the inventory value just a shade less. Cash flow from operations looks really good at $4.5 million for the year and that's nice to see, but if you're paying attention, that's going to be a one-time boost selling all those homes. Now, we're going to have to see this reinvention work. Are they going to be able to generate solid cash going forward?

Chris Hill: Yeah, it's interesting because we've seen this with other businesses in other industries, where essentially they try something, it doesn't work. It's expensive and it takes a while to essentially work their way through that. If you're just coming to Zillow with fresh eyes and you look at what they went through over the past couple of years, it's understandable to say, alright, in some ways they are starting fresh, and let's see what they can do.

Jim Mueller: Exactly. They're focusing on rentals, generating mortgage business, selling through partner agencies, virtual tours. The last one sounds really intriguing. At the end of last year or the start of this year, I'm not sure which. They bought a photography and video company. They're using that to get really good shots at the homes, as well as it's going to play into something they're calling real-time touring. For the buyer, you can sit at your computer and get a live tour of the house in a different city. Which is pretty cool. Not so cool for those seller of course but when you're showing a home, you're not allowed in the house anyway there's that.

But that may be a temporary advantage. That's just a technology trick that I'm sure one of their competitors Redfin is going to latch onto fairly quickly, but they're becoming more traditional online real estate company. One thing they did that intrigued me, they're still related to iBuying. Last August they announced a deal partnership with Opendoor Technologies, technology technologies, Opendoor. They launched that in Atlanta, I believe. Just this current quarter and they had some early comments on that. Opendoor, of course, it's an iBuyer, makes a cash offer. But what they're doing is that cash offer will be fed to the buyer alongside the Zestimate.

Zillow's estimate of what the fair market value would be what they can sell their house for. The buyer can choose which one they want to go through. If they go with Opendoor for the cash, Opendoor pays a finder's fee to Zillow, which will be nice. But I don't think Opendoor is going to make money off of this. iBuying might be on its last legs. Don Molyneux is the operator of Pretium I think I got that right. The country's biggest residential landlord said iBuying will probably disappear within next two years, mostly because iBuyers are forced sellers. They can't hold onto that. They shouldn't have to hold onto that inventory too long. Which means you better get that purchase price right.

Chris Hill: Yeah. The partnership with Opendoor is, on the one hand, interesting to me, just because, you can look at it through the lens of, hey, they used to be rivals in this space and now they're teaming up. On the other hand, I'm still coming back to the point you just alluded to, which is like iBuying as a business doesn't seem to be a particularly profitable one and maybe this is a slight net positive for Zillow. But is it fair to assume that if this partnership is a net positive for Zillow, it's not a growth engine that shareholders or potential shareholders should be counting on?

Jim Mueller: I don't think so. The cash offer was certainly convenient and nice and good to have for the house seller, but would probably be less than what they can get on the open market. Because of course, the iBuyer has to make a profit. But that whole idea forgot the lessons of the housing crisis back in 2007, 2008, where we've discovered that house prices can fall and that's what happened when the mortgage rates went doubled in the first six months last year. When the house prices fall, it's not a fun business to be in, and house prices are probably still falling, maybe stabilizing a little bit as mortgage rates settled in but it's still a really unknown. It's going to be an interesting year let's put it that way.

Chris Hill: It absolutely is. Real quick, you mentioned Redfin earlier. Redfin reports after the closing bell today. What is one thing that investors should keep an eye out for when looking at Redfin's results?

Jim Mueller: Real quick disclosure, I own shares and I'm following along with the options investment idea that I put in on Redfin. With that out of the way, I'm going to be looking for what their rental business is doing. They bought Rentpath in April 2021 out of bankruptcy and they put in place a new CEO and they've spent couple of years reinvigorated in that business and tying it into their online business. Knowing that renters become buyers and sellers can become renters and there's a lot of nice cross-selling. Zillow is doing the same thing as well. But I want to see what did they actually show a profit in the fourth quarter like they were supposed to? Like, I think I was going to say no or I'm sorry, was cash-flow positive there within the fourth quarter, and see if that actually happened, and see how much integration that's happening for Redfin.

Chris Hill: We'll keep an eye after the closing bell. Jim Mueller, thanks for being here.

Jim Mueller: Thanks, Chris.

Chris Hill: Let's face it, as human beings, we tend to focus more on what's right in front of us. If you're a Wall Street analyst, you're forgiven for paying a bit more attention to companies that are closer to New York city. But for investors, that just means there are opportunities in good businesses that are underfollowed. In part due to where they're located. Ricky Mulvey caught up with Motley Fool senior analyst Sanmeet Deo to take a closer look at a couple of businesses between the coasts that are serving investors well.

Ricky Mulvey: Do you think investors like pay a price for cool? I guess the second question is, is that price ever worth it?

Sanmeet Deo: Definitely mean you'd look at a company like Lululemon and their products are trendy, they're hot, they're pricey, they're seeing all over in hot fitness concepts they're also not just used for fitness, they're used as athleisure. They pretty much launched almost the athleisure category. When you see that logo, it's almost been iconic and you know, that's an expensive piece of clothing there the person is wearing. It is cool though they're trendy for wearing it. I would imagine that Lululemon's stock benefits from a little bit of like a cool premium, whether it's worth it or not, it depends on how the business does. Lululemon has been a good business. They sell their premium-priced products, their demand is hot. They've expanded their categories, expanded their line, and made companies like Nike and other competitors really take notice and launch their own brands in those categories. For Lululemon, it's definitely been worth it for some, it's maybe not so much. It really just depends on how the business performs.

Ricky Mulvey: The person wearing Lululemon, I would say is trying to be cool, versus is cool?

Sanmeet Deo: Yeah. Or they could be, you never know.

Ricky Mulvey: Hard to say who is cool. But speaking of things that are uncool, a lot of good investments are very uncool. You were chatting earlier on Slack where there's this idea of like a Wall Street lag, especially for businesses that primarily exist outside of the coasts.

Sanmeet Deo: This is something that's been written about primarily. I know from the first time I ever heard of it, it was Peter Lynch, the legendary investor and he wrote about one of the edges that consumers have, when they're looking for winning companies and stocks among smaller cap type names, is that store that you come across in your local neighborhood or the product that you buy that all your other friends or people that you know are buying. When you're able to identify that, and then you dig in and see what was this an investable company or is this a company that's actually doing well? You may be able to catch that trend before Wall Street does.

Wall Street might notice it later, at a later stage of their growth, he labeled this is a Wall Street lag. One primary example of that was The Limited. It was based out of Columbus Ohio, went public in 1969 by '74, they only had to Wall Street analysts covering it. By '75 T Rowe is a first institution that actually bought the company stock. That's when they had about 100 stores open across the country. Even in 1981 when they're 400 stores, there's only six analysts that cover the stock. The Limited became a pretty big winner for Peter Lynch in his investment fund.

Ricky Mulvey: That was also the case with restaurants too Chipotle.

Sanmeet Deo: It's funny because Chipotle was one of the names that when I was in college, we used to go to all the time, and I went to college, University of Texas. In Texas plenty of places, the Mexican. Tex mex, burritos, tacos wherever you want, local places. Chipotle was thriving. It was doing well in a college scene, in a scene or there's plenty of competition. I thought the food is quite good, very easily accessible, reasonable at that time at least.

It was a name that I followed, it turns out they started in Colorado, started expanding out across the west and other states before they finally did hit New York. I remember I was working in an investment firm when Chipotle announced that they're going public, and most everyone was like, well burrito chain, like how could you have a whole burrito chain as a public company and will do well. I thought to myself, the thesis is as simple as well. It did pretty well on Texas against pretty stiff competition. It has a translatable business model and food, so I think it could.

Ricky Mulvey: If you can sell burritos in Texas, you can sell burritos anywhere. This is irrelevant, but I'm near the first Chipotle and it's like a quarter of the size of all the other Chipotles. I had this magical thinking that the food would be significantly better and it's just a regular Chipotle. I've started to go to others. Now, the location thing is interesting because I don't think, that trend has necessarily died, especially for a company like Shake Shack and I'm not trying to be a hater, it's trading at like 2-3 times sales, which seems relatively ish reasonable for a restaurant company, but it's got a forward PE multiple of more than 400. I think some of the hype and some of the coverage is due to its locations. It started up in New York, so you figure there might be some Wall Street analysts who are more familiar with the brand because they can eat the burger.

Sanmeet Deo: Absolutely, and it was started by a famous restaurateur who owns a few different really fancy, fine dining establishments in New York City. I would think it could be as easy as analysts go down the street to their local Shake Shack, try it out and say, hey, this is a pretty good product. Hey, turns out they're actually going public. I think they'll do pretty well. It turns out Shake Shack was almost like the next Chipotle. There's been a lot of next Chipotles where Shake Shack was definitely one that they were calling it the fine casual category or and while it's done reasonably well, it hasn't been the blockbuster success than Chipotle has been.

Ricky Mulvey: I'm still surprised by the coverage. It's about a two billion-dollar company. It's got 20 analysts covering it, according to Yahoo! Finance. To me, that seems a little high for context a restaurant that is, I would argue significantly less cool, but still tasty is Cracker Barrel. I think it has more locations, smaller market cap, and it has about half the number of analysts covering it than Shake Shack. I think it drives to this question that markets are efficient sometimes, but do markets become less efficient when you have fewer analysts covering, accompany, it would seem so when you have fewer eyes picking the number of gumballs in a jar, if you will.

Sanmeet Deo: Yeah, for sure because a lot of investors will rely on Wall Street research, and analysis on what this company is doing, how is performing, whether it could be the next big thing, and when everyone's picking it apart, when you have a company that isn't followed by many analysts and may not be talked about as much. It might not be in your neighborhood, but it might be one of those local niche favorites, whether it be a restaurant or retailer or whatever have you, that is doing successfully in its niche and its area of expertise. It's definitely small-caps or and companies that are less followed are definitely less efficient. That's actually one of the things that Peter Lynch himself to talked about investing in where you could, as a consumer, as an everyday individual investor could gain an edge.

Ricky Mulvey: I think one case for that right now might be Winmark. It's a resell franchisor, we've talked about on the show a little bit. They do Plato's Closet played against sports. They do not have analysts conference calls, although they released regular reports. Its market caps around a billion dollars, and it has exactly zero analysts covering the company. For Winmark, I would assume they like flying under the radar like that and having fewer eyes on them so they can just basically continue to perform.

Sanmeet Deo: Absolutely. This is a billion-dollar market cap business almost with over 1,200 stores and many locations all across the country among their, I think it's four or five brands that they have selling second-hand items from sporting goods, children, teen clothing, musical instruments, women's business and casual tire, a hodgepodge of different products that are second-hand items. Not very cool, I guess. You're not cool if you're buying secondhand stuff. It's based out of Minneapolis, Minnesota. It's in the middle of the country, but I even looked up a couple of their brands to see if they're, I live in Long Island and there's maybe even in New York itself, there's just a handful of some of the brands.

Not well known either in not probably written about in the Journal or other publications. So but they're cash-flow-positive, high returns on investment franchise business that is consistently knocking out of the park.

Ricky Mulvey: Great place to buy a softball glove. Difficult company to talk about often on a daily show. It's just they're, chugging along and people are still buying resale stuff. I want to talk about some other companies that we're kicking around some companies that may be fail the cool test, but pass the good investment test.

Sanmeet Deo: One name that has been a old full rack that has done very well. It's called Tractor Supply. They're based out of Brentwood, Tennessee. Retailers servicing recreational farmers ranchers, selling all kinds of products, feed for farming. They have about 2,000 plus stores with an annual revenue of over $14 billion. Their concentration of stores are most in states like Texas, North Carolina, Pennsylvania, Tennessee, Georgia, Michigan, Ohio, and the stock is annualized over 25 percent, over 25 years. It's been a fantastic name that had you held for over a long period of time has done phenomenally well, but how cool is ranching and farming equipment and supplies?

Ricky Mulvey: I don't know that you guys in New York, but out here it's pretty cool. It's one of those businesses too where it's selling a lot of need-to-have not nice-to-haves. Where this is where you're getting your chicken feed and replacement parts for things. I think that's something that will continue to do well. Sanmeet, always great catching up with you.

Sanmeet Deo: Thanks for having me. 

Chris Hill: As always, people on the program may have interest in the stocks they talk about. On the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.