Realogy Faces Its First Test

Cendant's (CD) spinoff of its real estate brokerage business could surely have come at a better time, given that the U.S. housing market is slowing at a rapid pace.

Proponents, however, say that the new company is underleveraged and generates stable free cash flow, which will allow it to pick up attractive acquisitions and ride out the expected downturn in home sales over the next year and a half.

Shares of the brokerage company Realogy (H) began trading Tuesday and recently changed hands at $25.18. Cendant shareholders received one share of Realogy for every four Cendant shares they owned. (Shares of Cendant's hotel spinoff, Wyndham Worldwide (WYN) also begin trading Tuesday. Cendant shareholders receive one Wyndham share for every five Cendant shares they own.)

Realogy generates about two-thirds of its earnings from its franchise business through its five well-known brokerage brands: Century 21, Coldwell Banker, ERA, Sotheby's International Realty and Coldwell Banker Commercial.

The remaining profits come from the company's lower-margin brokerage house business, which includes the Corcoran Group -- one of New York City's biggest residential brokers -- along with relocation and settlement services.

Because of the slumping housing market, Realogy recently lowered its forecast for 2006 earnings before interest, taxes, depreciation and amortization. The company expects EBITDA of $925 million to $1.05 billion in 2006, down from $1.1 billion in 2005. The company had previously forecast a flat year. Growth will resume in 2007, the company says, though it hasn't provided specific guidance.

Realogy projects 2006 net income of $380 million to $465 million, down from $497 million last year. At $25, the stock trades at 15 times the midpoint earnings-per-share guidance of $1.69.

"Investors at this point are perhaps looking at the downside of the real estate cycle and not assigning a high value to Realogy," says Gautam Dhingra, portfolio manager with High Pointe Capital, which owned shares of Cendant and now Realogy. "But that's exactly what gives it the opportunity."

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