Etsy Stock: Not The Next eBay (NASDAQ:ETSY)

Introduction

The primary time I did my analysis on ETSY (NASDAQ:ETSY) was in April 2022. I posted my findings within the personal Discord neighborhood (Fired Up Wealth) that I’m part of, led by Motley Idiot contributor Eric Cuka. At the moment, I used to be fairly bullish, and why should not I be?

Again then, the corporate was anticipated to see a 7% decline in earnings progress in 2022 earlier than bouncing again with a vengeance in 2023 with 34% in earnings progress, adopted by 29% earnings progress in 2024. That averages out to be 18.7% in adjusted working earnings progress over three years. Certain, any fall in earnings wouldn’t be good, however that definitely didn’t justify a 56% plunge in inventory worth from $291 in November 2021 to $127 by April 1, 2022.

Morningstar analyst Sean Dunlop write a observe in February 2022 with the next title:

In that article, he described Etsy as a “wide-moat” firm that has “carved out a permanent area of interest in a rapidly evolving e-commerce area, with two-year stacked GMV progress of 154% for the quarter (down simply 4 proportion factors sequentially), suggesting to us that the agency’s market share good points ought to show enduring“, ending off his observe by maintaining intact his $221 honest worth estimate for Etsy.

Not one to base my purchase or promote resolution on analysts’ honest worth estimates blindly, I proceeded to mannequin my very own valuation estimate for Etsy (see desk under), throwing in a worst-case state of affairs of a ten% probability of a ten% decline in earnings in 2022 (in comparison with FactSet analysts’ forecast of a 7% decline in earnings) adopted by simply 10% earnings progress per 12 months for the next 9 years (in comparison with the 34% and 29% of constructive earnings progress that have been forecast for 2023 and 2024 respectively).

In my honest worth estimate, I derived a a lot decrease $166.74 per share honest worth for Etsy shares in April 2022; Etsy’s shares have been priced at $125.72 a bit at the moment which meant that I might personal Etsy shares with a 32.6% margin of security based on my valuation. Even when my worst-case state of affairs occurs and Etsy’s share worth falls to $99, evaluating a doable 21% decline to a possible 32% upside to my honest worth calculation, or the even increased 75% achieve if the inventory worth strikes in direction of Sean Dunlop’s honest worth for Etsy, the danger and reward gave the impression to be in my favor, and I purchased some shares of Etsy for round $126 per share that very same month in April 2022.

The bear market of 2022 crushed Etsy’s inventory worth, alongside different pandemic darlings. Nonetheless, I doubt anybody anticipated a 70% collapse within the share worth by 70% from its all-time excessive to essentially the most lately transacted worth, particularly not for a worthwhile firm.

I used to be fortunate to have offered all my Etsy shares in December 2022 for $140 apiece. My resolution to promote was primarily based on my short-term outlook for the business in addition to to extend my money place in preparation for better-valued buys.

With the present share worth of $87.56 as of the shut on June 8, 2023, which is near the 6-month low of $81, I’m questioning if the danger and reward for Etsy has turned favorable once more.

On this article, I’ll study Etsy from a price investor’s viewpoint to find out whether it is value proudly owning. I need to know is the inventory damaged or is it simply the worth that’s damaged.

Let’s go.

ETSY’s Enterprise In A Nutshell

In response to Etsy’s 2022 10K,

Etsy operates two-sided on-line marketplaces that join thousands and thousands of passionate and inventive patrons and sellers world wide. These marketplaces – which collectively create a “Home of Manufacturers” – share our mission, frequent levers for progress, comparable enterprise fashions, and a robust dedication to make use of enterprise and know-how to strengthen communities and empower folks. Our main market, Etsy.com, is the worldwide vacation spot for distinctive and inventive items made by impartial sellers.

The Etsy market connects artistic artisans and entrepreneurs with considerate shoppers searching for objects which can be a joyful expression of their style and values…

Now we have a seller-aligned enterprise mannequin: we generate income when our sellers generate income. We provide Etsy.com sellers a market with tens of thousands and thousands of patrons together with a variety of vendor instruments and companies which can be particularly designed to assist our artistic entrepreneurs generate extra gross sales and scale their companies.

Along with our core Etsy market, our “Home of Manufacturers” consists of Reverb Holdings, Inc. (“Reverb”), our musical instrument market acquired in 2019, Depop Restricted (“Depop”), our vogue resale market, and Elo7 Serviços de Informática S.A. (“Elo7”), our Brazil-based market for handmade and distinctive objects. Each Depop and Elo7 have been acquired in July 2021.

Is The Enterprise Damaged Or The Inventory Damaged?

Let’s study this from the next views.

Is the corporate worthwhile?

Etsy has had constructive income and working money circulate proper from the start in 2014. From 2014 to 2022, income elevated 12.2 occasions to $2.6 billion, internet working money circulate elevated by 55.5 occasions to $683.6 million, and the amount of money and money equivalents elevated by 12.5 occasions to $1.2 billion. The corporate has additionally been reporting constructive internet earnings since 2017 (extra on the unfavourable internet earnings for 2022 later).

It is a worthwhile enterprise, little question. Because of the pandemic and stay-in-home directives globally that led many to buy on-line, Etsy’s income doubled from $818 million in 2019 to $1.7 billion in 2020. Such speedy income progress was undoubtedly unsustainable particularly when the world returned to normalcy. Income progress slowed to 35% from 2020 to 2021 and additional declined to simply 12% from 2021 to 2022. Issues obtained worst for corporations lumped into this bucket (resembling Zoom and Sea Restricted) when a confluence of unhealthy issues occurred in 2022; the sudden and speedy enhance in rates of interest to 40-year highs, the conflict in Ukraine, provide chain points that endured to delay shipments and enhance prices, and many others. The bear market that tore investor confidence to shreds didn’t assist.

But, let me be crystal clear: Etsy was worthwhile and stays so.

If it have been worthwhile, why did the corporate report a unfavourable incomes per share of $5.48 for the fiscal 12 months 2022? The recorded unfavourable incomes in 2022 was as a result of firm writing down the worth of their acquisitions of Depop and Elo7. The next is from the Q3 2022 earnings name,

Earlier than transferring to the stability sheet, I am going to touch upon the non-cash impairment cost of about $1 billion we recorded on the goodwill of Depop and Elo7, eliminating the complete quantity of goodwill we have been carrying for every model. We bought these companies when know-how and client firm valuations have been at a lot increased ranges. As an example, many friends have seen enterprise values decline by 70% or extra…

With out this $1 billion impairment value, as an alternative of $694 million in internet earnings loss, Etsy ought to have reported a internet earnings of $351 million, which might be barely increased than the 2020 reported internet earnings.

Will the corporate stay worthwhile?

For an e-commerce firm to continue to grow, the variety of lively patrons (demand) and lively sellers (provide) have to extend. If an e-commerce firm has fewer and fewer prospects shopping for from it, it’s doubtless that it’s experiencing a decline. This facet is mentioned in my article on one other e-commerce firm eBay Inc (NASDAQ:EBAY).

In Etsy’s case, the reply shouldn’t be so easy.

Compared on a year-on-year foundation (see desk under), the variety of lively patrons has been on the decline, from 96.3 million in 2021 to 95.1 million in 2022, and in the latest quarter, it was simply 89.9 million.

However when in comparison with the pre-pandemic determine of 46 million lively patrons in 2019, the present variety of lively patrons remains to be virtually twice that in 2019. The pull-through enlargement in demand in 2020 and 2021 has elevated the adoption of e-commerce globally and introduced in prospects within the distinctive merchandise out there solely on Etsy in better numbers at a tempo sooner than beforehand anticipated, therefore seeing a slight decline within the variety of lively patrons year-on-year from 2021 to 2022 is regular. Corroborating knowledge would be the falling variety of new patrons added annually, down from the height of 38 million added in 2020 to 35 million in 2021, then an extra decline to 29 million in 2022. It’s too early to foretell if the 6.7 million new patrons added in Q1 2023 is off to an excellent begin or not, but it surely does signify a decline in new patrons in comparison with the 7 million added in the identical quarter in 2022.

On the identical time, whereas understanding that explosive progress in lively patrons and new patrons in 2020 and 2021 is unsustainable, buyers shouldn’t understate the dangers that include these declining numbers as a result of the decline of greater than 5 million lively patrons from 2022 to Q1 of 2023 might recommend that Etsy has some difficulties in retaining current patrons, and if that could be a actual downside and never a short lived blip, then the conversion of those lively patrons to the a lot coveted ordinary patrons (individuals who spend $200 or extra within the final 12 months) can be tougher, and it should additionally imply extra effort and cash needs to be spent to reactivate the previous lively patrons.

Already, a few of these points have reared their head. As you possibly can see from the desk above, the variety of ordinary patrons has declined from 8.1 million in 2021 to 7.4 million in 2022 and to 7 million in Q1 of 2023. The lack of a million ordinary patrons signifies a lack of not less than $200 x 1 million = $200 million in internet income, the equal of seven.8% of 2022’s full-year income.

And despite a 55% enhance in SG&A bills (excluding R&D) from $655 million in 2020 to $1.02 billion in 2022, the variety of reactivated patrons elevated by simply 9% from 22 million to 24 million. Briefly, it’s costing increasingly promoting cash simply to maintain the churn beneath management by reactivating patrons and maintaining lively patrons lively.

One other set of figures that buyers ought to be watchful of is the Gross Merchandise Gross sales (GMS). The GMS figures exclude income from companies, so increased GMS numbers point out that sellers are doing higher, in addition to the satisfaction of Etsy’s patrons, and the well being, scale, and progress of Etsy’s enterprise. Primarily based on the entire recorded GMS, it will appear that Etsy’s GMS has declined from $13.49 billion in 2021 to $13.31 billion in 2022. Nonetheless, making an allowance for one class of merchandise, face masks, was offered in large portions within the years 2020 to 2021, a feat that’s unlikely to repeat anytime quickly, income from the sale of face masks ought to be stripped out. After doing that, it turns into clear that GMV has been growing 12 months on 12 months from 2018 to 2022 (see inexperienced arrow).

I believe it’s arduous to say if Etsy is now at the beginning of a long-term decline (like eBay has been for years), or if the expansion normalizing to a post-pandemic charge. What I can say is that pre-pandemic, the administration had been excellent, trouncing analysts’ 1-year and 2-year earnings and gross sales estimates handily (see desk under).

Valuation and Progress

From 2017 to 2019, buyers have been continuously paying in extra of 44x adjusted working earnings for Etsy’s progress, which made sense as Etsy’s adjusted working earnings have been 278% in 2017, 32% in 2018, and 25% in 2019, a mean charge of 111% per 12 months. Etsy deserved that form of premium again then.

Earlier within the article, I already talked about that the recorded loss in internet earnings in 2022 was on account of an impairment cost reasonably than a deterioration within the enterprise.

Therefore, for the aim of my fascinated by Etsy’s future progress charge and its valuation, I’ll think about that the lack of 2022 is absent and skip that 12 months. Etsy’s adjusted working earnings of $3.40 per share in 2021 to $2.45 per share in 2023 (if analysts are proper, and if Etsy didn’t outperform these estimates) represents a 28% decline. Along with the analysts’ expectations of a 22% achieve in 2024 and 18% in 2025, the typical adjusted earnings progress charge for these three years (2023, 2024, and 2025) works out to be a paltry 4%.

How a lot premium are buyers prepared to pay for every greenback in Etsy’s earnings in a post-pandemic, post-lockdown world the place the assumed progress charges in 2024 and 2025 though nonetheless double-digits are considerably decrease than the pre-COVID years?

I severely doubt that buyers will proceed to pay 40x earnings for a corporation that’s rising at a mean charge of simply 4%.

If we’re beneficiant and assume the 28% decline from 2021 to 2023 has been baked into the beaten-down inventory worth, and the typical adjusted earnings progress charge for 2024 and 2025 ought to be 20% per 12 months, I’ll nonetheless be uncertain that Etsy deserves the identical premium it commanded from 2017 to 2019 when it was rising at a mean charge of 111%.

Regular Case: Assuming that Etsy grows earnings at 20% per 12 months and instructions a premium of 20x earnings (utilizing Peter Lynch’s PE = Progress charge), for $2.98 of earnings in 2024 the inventory could possibly be value $2.98 x 20 = $59.60.

Good Case: If Etsy outperforms properly because it did previously, earnings develop by 30% per 12 months to $3.185 in 2024 and it instructions a premium of 30x earnings, the inventory could possibly be value $3.185 x 30 = $95.55 in 2024.

Extraordinary Case: If Etsy outperforms beautifully because it did previously, earnings develop by 40% per 12 months to $3.43 in 2024 and it instructions a premium of 40x earnings, the inventory could possibly be value $3.43 x 40 = $137.20 in 2024.

Assuming that every of those three situations has an equal probability of success, the typical of those three leads to $97.45. Primarily based on the closing worth on June 8 of $87.56, that may imply an 11.3% upside in 18 months.

Though I imagine it’s barely undervalued on the worth of $87.56 and will doubtlessly return 11.3% by the top of 2024, I’ll take into account Etsy a HOLD at this worth as I deem the margin of security inadequate. Though the potential for worth appreciation is important in my best-case state of affairs, and there may be nonetheless a possible 11.3% worth appreciation after contemplating the opposite two situations, I’ve but to think about a worst-case state of affairs. What if, on account of a slow-growing financial system the place wages usually are not rising as quick as inflation of products and companies, the place every part from meals to hire prices extra, and the typical particular person finds themselves having to stretch each greenback to succeed in the subsequent payday, demand for distinctive, handcrafted objects on Etsy would doubtless fall.

There have been round 46 million lively patrons in 2019 and Etsy introduced in $0.79 in adjusted working earnings in that 12 months. To illustrate every part normalizes in 2023, and for example the variety of lively patrons in 2023 grows to 92 million, double that of 2019 and better than the recorded quantity in Q1 2023. Assuming a 153% enhance within the adjusted working earnings to $2 per share in 2023, even at a premium P/E of 40x earnings that may get to simply $80 per share, decrease than the worth at shut on June 8, 2023. And if earnings do develop by 20% to $2.40 in 2024, even at a P/E of 40 the inventory worth will solely be $96. The danger and reward don’t appear to be very favorable.

Conclusion

I imagine that Etsy is a inventory that’s not damaged. Etsy is certainly not the subsequent eBay. Etsy stays worthwhile and primarily based on GMS figures alone (excluding face masks gross sales of 2020 and 2021) income has truly been rising yearly. To not point out it has a money hoard of $1.2 billion to deploy so it doesn’t have to borrow cash on the elevated charges presently. Flush with money, and with the share worth declining for the previous many months, the corporate has been shopping for again shares over the previous 4 quarters.

• Q2 2022 Repurchased $62.2 million in inventory
• Q3 2022 Repurchased $151 million in inventory
• This fall 2022 Repurchased $150 million in inventory
• Q1 2023 Repurchased $148 million in inventory

Within the phrases of CEO Josh Silverman within the Q1 2023 earnings name,

… we successfully utilized a portion of our money to repurchase shares to offset dilution ensuing from stock-based compensation.

Whereas it’s disheartening to see that executives have been promoting their very own shares reasonably than shopping for them even on the depressed worth ranges, it’s of some comfort that administration has been shopping for again shares thus managing the influence of the dilution on the reported earnings per share.

One other level to say is the more and more rising piece of the income pie comes from the “Providers” section, which has been growing properly from $160 million in 2018 to $660 million in 2022. This section presently makes up 25% of Etsy’s complete income offering an extra income with levers that administration can pull if there’s a want to extend income, prefer it did in 2022 when it elevated the sellers’ transaction charges by 30% from 5% to six.5%.

Administration has confirmed themselves to be nice at main and rising Etsy within the years pre-pandemic. No one is ideal, however primarily based on their previous efficiency, there isn’t a cause to suppose in any other case of them.

In case you are holding Etsy’s shares now, I like to recommend holding on to them.

In case you are contemplating Etsy as a recent funding now, I recommend holding off till there’s a bigger margin of security, or till you see the variety of lively patrons and ordinary patrons rising once more.