Etsy (ETSY, Financial) is a unique e-commerce website which focuses on vintage and hand-made items. The company’s niche offerings have proven to be extremely popular with customers and got an extra boost during the beginning of the pandemic, as people were stuck at home and craving inspiration. The stock price skyrocketed over that period and increased by over 800% from a $31 low to a $828 high in November 2021. I personally was an investor during that period and managed to rack up a 355% gain before selling the stock at the highs.
Since December 2021, the popping of pandemic stock bubbles and the high-inflation environment have tanked Etsy's stock. The stock is down ~75% since then, but it has begun to rebound since mid-June leading up to and following a strong second-quarter earnings release. Could this stock now be a value opportunity given its excellent prospects and more reasonable valuation?
Business model
Etsy’s mission is to become the “starting point” for e-commerce journeys. The company isn’t trying to compete with Amazon (AMZN, Financial), which offers an “everything store” of cheap goods. Etsy is more niche. People visit the Etsy website to discover and purchase unique and creative items across Home and Living, Jewelry, Clothing and many more categories.
In order to search the 100 million unique items, Etsy has evolved its smart search engine to include not just which words you type, but also what other items you may like based on your past behavior. The company’s technology even includes advanced machine learning algorithms in order to generate optimal results for users.
The company is testing a range of “Visual Experiences” which includes a TikTok style news feed for inspiration, video reviews and even live streaming events. Etsy is continually innovating its platform and has rolled out the ability for a customer's saved items to be highlighted when on sale, which should increase conversions.
Etsy offers "buy now pay later" with Klarna and introduced a “purchase protection program” to ensure a more trustworthy and reliable service for customers.
Advertising is a key growth segment which has increased in revenue by a staggering 516% over the past five years, and seller ad budgets are up 80% year to date.
Etsy has expanded its portfolio of businesses through a series of acquisitions. These include “the Etsy of Brazil,” Elo7, and the $1.6 billion acquisition of Depop, a second-hand clothing app, in 2021. Prior to this, the company acquired Reverb, a leading marketplace for new and used musical instruments.
These acquisitions all help to expand the company’s two-sided marketplace. These platforms all benefit from a flywheel effect of more sellers, more buyers, more revenue, etc.
Better than expected quarter
Etsy generated better than expected earnings for the second quarter of 2022. Revenue popped to $585, which beat analyst estimates by $28 million and represented a 10% increase year over year. This was driven by strong growth in the “Home and Living” category, which was up 30% year over year and 170% over the past three years.
Gross Merchandise Sales was $3 billion, which was down slightly year over year (-0.4%) but still up 177% over a three year period.
Adjusted Ebitda rose to $163 million, up 17% year over year, with a strong 28% adjusted Ebitda margin. Earnings per share (EPS) was $0.94, which beat analyst expectations by $0.24.
The company is investing a substantial 17% of its revenue into product development, which is greater than the 12% invested in the full year of 2021. In addition, Etsy has consolidated together its product development from multiple entities including Depop and Elo7, which should result in greater efficiency in the longer term.
Etsy has gradually improved the efficiency of it’s marketing spend, which was 28% of revenue in the second quarter. This was a lower percentage than the ~30% of revenue in prior quarters.
Etsy has a capital light business model and is in a strong cash position with $1.1 billion in cash. However, the company does have a substantial $2.3 billion in long term debt which is fairly high for a young “growth” company.
Is the stock undervalued?
In terms of valuation, Etsy is trading at a forward price-sales ratio of 5.55, which is ~42% cheaper than its historic five-year average. In addition, the company trades at a price-earnings ratio of 28, which may not seem cheap at first glance but is 46% cheaper than its five-year average. In addition, it should be noted the company is investing aggressively into product development. High growth going forward could sustain or even grow the valuation multiples.
The GF Value chart indicates a fair value of $198 per share, which means the stock is significantly undervalued at the $108 share price it trades at the time of writing. However, the GF Value chart does warn of a possible value trap due to the slowing revenue growth of the company.
Final thoughts
Etsy is a fantastic company and truly has a unique place in the e-commerce market. Management is continually innovating, and despite slower growth than over the pandemic, its recent earnings are better than expected. The stock is undervalued based on historical valuation levels as well as GF Value and thus could be a value opportunity in my view. However, investors should be wary that the current market environment is likely to make Etsy more volatile in the short term.
