What happened
Shares of Opendoor (OPEN -3.72%) climbed 22% last month after an unexpected jump in existing home sales. The real estate tech company has been struggling with a difficult residential real estate market, but the February market data revealed that sales volume grew for the first time in more than a year. The stock also benefited from momentum across the tech sector as investors revised expectations for the Fed's rate-hike timeline.
So what
Opendoor operates an e-commerce platform for residential real estate. Unlike other popular e-commerce platforms that simply connect buyers and sellers, Opendoor actually purchases homes, then sells them. It generates profit on the spread between purchase and sale price.
Unfortunately, economic conditions have made that model difficult. Opendoor's profit margins are narrow, and they have been squeezed harder as home prices fell over the past year. Rising mortgage rates are crushing demand for homes. The company exited 2022 with nearly $4.5 billion in unsold inventory on its balance sheet, which was more than 150% of its fourth-quarter sales volume. Even worse, the company spent more on sales and marketing during the quarter than it generated in gross profit. Things have been rough.
Image source: Getty Images.
March brought several promising signs that the most painful part of this cycle could be over. First, the Fed gave hope that interest rate relief is on the horizon. While the central bank announced another rate hike in March, its forward-looking commentary seemed to soften, causing many investors to speculate that policy would be less restrictive in the second half of 2023.
Then, analysts were suprised by data that showed a 15% month-over-month increase in home sales volume during February. This trend was seen in every region of the U.S., and inventories remained low. That puts upward pressure on pricing, and it should help Opendoor unload a significant amount of its own inventory to generate cash.
Now what
Opendoor had a good month, but it still looks fairly distressed. Shares peaked at nearly $35 in 2021, and they're now under $1.70 even after the recent recovery.
The company's new CEO has wisely turned the company's focus to profitability, and the company was able to generate positive free cash flow for 2022 after trimming inventory. That might not be good enough, though. With only $1.3 billion in non-restricted cash left on the balance sheet, Opendoor may have to accept unfavorable financing terms to extend its cash runway. It's unlikely to operate at a profit until macroeconomic conditions improve. Many of the company's home sales in recent months were made at a loss, which obviously isn't sustainable. With a recession on the horizon, conditions might remain challenging even if mortgage rates go back down.
Things could also sour if shares go below $1 and exchanges threaten to de-list the stock. That would be bad for trading volume, and it would result in lower demand. There are ways to work around that issue, but it remains a risk.
Opendoor's share price reflects the likelihood of dilution and the high cost of capital. If the company can navigate a couple of tricky quarters, then this stock has lots of upside potential in the next bull market. However, there are serious obstacles to overcome that could seriously threaten shareholder value. This is a high-risk, high-reward play, so allocate accordingly.
