How Foxtons Group plc can rise 50% by 2019 despite 54% fall in profit

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Foxtons

Wednesday's full-year results from Foxtons (LSE: FOXT) show that the London property market endured an exceptionally difficult year in 2016. The estate agent recorded a 54% fall in profit and stated that 2017 is likely to be yet another uncertain year. Despite this, the company's medium-term outlook suggests its shares could rise. And if the London property market stabilises and picks up in the next two years, the company's shares could be trading as much as 50% higher.

A difficult year

Last year was a hugely challenging one for Foxtons. The EU referendum caused a high degree of uncertainty in the London property market. Alongside this, rises in stamp duty also meant that demand for property declined. This led to a reduction in the company's sales revenue of 23% during the year, with there being deterioration throughout the year. While the company's lettings business was relatively robust, even its revenue was 1% lower than in the prior year.

As a result of falling profitability, Foxtons has slashed its full-year dividend from 5.01p per share to 2p per share. It will also not pay a special dividend for 2016. While disappointing for income investors, this seems to be a sensible strategy given the difficult outlook which is expected to be faced in 2017. Despite this, the business was able to open seven branches in 2016 and two branches in February 2017. This demonstrates the degree of confidence it has in its long-term future.

Growth potential

Even though Foxtons faces a tough 2017, its performance in 2018 is forecast to improve significantly. Its bottom line is expected to decline by 5% this year, but then rise by 21% in 2018. Despite this high growth potential, it trades on a price-to-earnings growth (PEG) ratio of just 0.9. This suggests that its shares could rise by 50% and still offer fair value for money and a wide margin of safety. If they were to do so, Foxtons would trade on a PEG ratio of 1.3. This may be closer to its intrinsic value.

Certainly, an improvement in the outlook for London property transactions will be required in order for Foxtons to deliver high capital gains. However, with sterling remaining weak and the UK's economic performance being robust as discussed in Wednesday's budget, it would be unsurprising for investor appetite towards London property to improve.

A better option?

One of the company's sector peers, Purplebricks(LSE: PURP), may offer even higher returns over the next two years. It has been successful because it offers a significantly lower cost to property-sellers, while providing much of the same level of service of traditional estate agents. Therefore, its financial performance is expected to improve at a rapid rate.

For example, Purplebricks is forecast to move into profit next year and follow it up with earnings growth of 175% in the following year. This puts it on a PEG ratio of just 0.2, which indicates that its share price growth potential is higher than Foxtons. As such, it seems to be the better buy in what is a potentially highly profitable sector.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.