The Consumer Price Index (CPI) is the core measure of inflation in the U.S., and in June 2022, it recorded a 40-year high of 9.1%. That prompted the Federal Reserve to embark on the most aggressive campaign to hike interest rates in its history.
Higher interest rates can result in less borrowing power for the typical American, which directly impacts the housing market. With mortgage rates inching toward 8%, real estate technology company Redfin (RDFN 8.49%) says homebuyers on a $3,000 monthly budget have lost $40,000 in buying power over the past year alone.
Naturally, turbulence in the housing market is also bad for Redfin because the company generates revenue by providing a portfolio of services to sellers. In fact, Redfin stock has crumbled 93% from its all-time high.
But there are signs of better times ahead. Inflation has fallen dramatically in 2023, and many experts believe the Federal Reserve has finished raising interest rates. Some estimates even suggest interest rate cuts could be on the way starting next summer. If that's the case, here's why now could be a great time to buy Redfin stock.
Redfin has pivoted its business to meet the challenging housing market
Redfin recently reported that one in 15 homes for sale saw a price drop in the four weeks ended Sept. 24. It's a clear sign that demand is waning, and it's supported by existing home sales data from the National Association of Realtors. The latest numbers for August showed just 4.04 million sales on an annualized basis, which is the lowest level in six months.
Redfin saw this coming last year when the Fed started raising interest rates, and it acted quickly to protect its business from the downturn in demand. It closed its RedfinNow direct buying business, which accounted for almost half of its companywide revenue. Direct buying involved RedfinNow purchasing homes directly from sellers and attempting to flip them for a profit, which worked great when the real estate market was strong. But Redfin risked substantial losses on its inventory in an environment with low demand.
The company is now focused on its industry-leading brokering business, where it employs 1,792 lead agents covering 98% of the U.S. population. That level of scale allows Redfin to charge listing fees as low as 1% compared to the industry standard fee of 2.5%. That prompts more sellers to use Redfin, so it's a win-win for all parties involved.
Additionally, Redfin is expanding its portfolio of other services. Its mortgage business originated $1.2 billion worth of loans in the second quarter of 2023 (ended June 30), and while that was down year over year due to slowing demand and lower house prices, it was up a whopping 391% from the same quarter two years ago. That's a reflection of the longer-term trajectory of Redfin's mortgage segment.
As I touched on earlier, Redfin is very much focused on technology, so it's experimenting with artificial intelligence (AI) to make finding a home much easier. In May, it launched a plugin for OpenAI's ChatGPT chatbot that will present house hunters with the most suitable listings based on the parameters they enter. It could save users hundreds of hours otherwise spent scrolling through real estate websites.
Redfin is shrinking now in order to grow more sustainably in the future
The closure of RedfinNow leaves a gaping hole in Redfin's financials. Wall Street analysts predict Redfin will generate $1.1 billion in revenue in 2023, which would represent a 51% drop from last year.
However, it's worth noting that direct buying wasn't a profitable business, so beyond juicing the company's revenue, it wasn't contributing much else financially. Considering the risks associated with the segment, the closure could have long-term benefits. Redfin's focus areas like brokering are less capital-intensive, which paves the way for the company to turn profitable in the near future.
Redfin initially expected to deliver positive non-GAAP (adjusted) earnings before interest, taxes, depreciation, and amortization (EBITDA) before the end of 2023, but given how tough the real estate market is right now, management was forced to push that target out to mid-2024.
In any case, the long-term outlook for Redfin points to a healthier, more financially sustainable business.
Image source: Getty Images.
Why Redfin stock is a buy now
Redfin stock is up 55% year to date on the back of management's efforts to insulate the company from the tough real estate climate. However, it's still trading 93% below its all-time high, which was set in 2021 when both the housing and stock markets were red-hot.
The company is now valued at just $750 million, and since it could generate $1.1 billion in revenue this year, that means its stock trades at a price-to-sales (P/S) ratio of just 0.7. That's near the lowest level since the stock listed publicly in 2017, and it's far below its peak P/S ratio of 7.7.
In essence, investors are pricing the company for failure. There are genuine risks for any company that has seen revenue plunge while reporting a loss every quarter. Nonetheless, it's hard to ignore Redfin's valuation right now measured against its revenue, especially if the company remains on a sustained path toward profitability. If interest rates stabilize as predicted and the housing market recovers in the new year, that could truly supercharge Redfin's financials. Its new conservative cost structure means any major boost to its revenue would drive a substantial improvement in its bottom line.
The risk-reward proposition for Redfin stock appears extremely attractive with more favorable times likely ahead.
