2023-06-13 00:36:14 ET
Summary
- Etsy's stock has sunk 20% year to date and is more than two-thirds below its peak, with GMS trends crumbling and margins wobbling.
- The company's revenue growth is being held up by one-time factors, such as a seller fee increase and advertising, but underlying GMS trends do not show a path back to fundamental growth.
- Etsy's niche popularity during the pandemic may not be sustainable amid tighter spending conditions, and the company's profitability is stuck at relatively low levels without significant growth rates.
- The company's high-teens adjusted EBITDA multiple isn't supported by current fundamental trends.
There has been a sea change in tech platforms that were hyper-popular during the pandemic versus sustaining that strength now. Amid tightening macroeconomic conditions and consumers exercising more caution over spending, Etsy ( ETSY ) has seen a dramatic change in its fortunes since the pandemic, when marketplace sales even excluding mask sales were multiplying year over year.
Year to date, shares of the arts-and-crafts marketplace have sunk 20%, and relative to pandemic-era highs near $300, the stock is still more than two-thirds below its peak. In my view, Etsy's heyday has passed, and especially as GMS trends continue to crumble and margins start to wobble, investors should exercise extreme caution.
Previously neutral on Etsy, I'm now switching my recommendation on the stock to bearish. What investors should be incredibly careful of at the moment is the fact that Etsy's revenue growth is being held up by what I view to be one-time factors (a seller fee increase as well as a kickoff into advertising), but underlying GMS trends do not give us confidence that there's a path back to fundamental growth in this business.
Here, in my view, are the major red flags for Etsy:
- Etsy's niche was popular during the pandemic, but amid tighter spending conditions the company may lose share. Etsy was applauded during the pandemic for having Amazon-proof ( AMZN ) categories that were quite unique, including crafts and musical instruments. In this rockier spending environment, however, consumer wallets are shifting back toward big-box (or simply delaying purchases), which is pushing Etsy further into irrelevance.
- Category-specific approach shrinks overall market opportunity. eBay ( EBAY ) is trying a similar approach - knowing that its niche is dying, the company is focusing on auto parts and collectibles. Etsy's focus on housewares and musical instruments also prevents the company from expanding its overall share.
- Out of one-time revenue drivers. Etsy has been able to mask its GMS weakness by implementing a seller fee increase as well as leaning into advertising in order to grow revenue. However, Etsy can't perpetually raise fees (its seller base is already quite vocal about fee hikes) or continue loading its site with ads, which will make the buying experience clunkier.
- Without leaping growth rates, Etsy's profitability is also stuck at relatively low levels. The promise of tech growth stocks is that high margins and high growth rates, over time, will help boost the company to soaring profitability levels. With Etsy's GMS growth stagnating, its adjusted EBITDA levels in the mid-20s margins are unlikely to see a major lift.
With this in mind, it's important to know that while Etsy looks cheap from a revenue multiple standpoint, knowing that Etsy doesn't have meaningful top-line growth from here on out means it's time to start shifting toward a profitability-based valuation approach.
At current share prices near $90, Etsy trades at a market cap of $11.19 billion. After we net off the $1.10 billion of cash and $2.28 billion of debt on Etsy's most recent balance sheet, the company's resulting enterprise value is $12.37 billion.
For the current fiscal year, Wall Street analysts are expecting Etsy to generate $2.76 billion of revenue, representing 8% y/y growth (the deceleration in the rest of the year relative to Q1 revenue growth rates is due to the fact that Etsy will comp last year's fee increases starting in Q2). And if we extrapolate out Etsy's ~27% Q1 adjusted EBITDA margin through the rest of the year, adjusted EBITDA will come out to approximately ~$745 million. This puts Etsy's valuations at:
- 4.5x EV/FY23 revenue
- 16.6x EV/FY23 adjusted EBITDA
In my view, there's not much appeal to investing in Etsy at these multiples. Stay on the sidelines until either GMS trends improve or Etsy's valuation significantly degrades from here.
Q1 download
Let's now go through Etsy's latest quarterly results in greater detail. We'll start with the core top-line GMS and revenue trends:
As shown above, GMS contracted -5% y/y to $3.10 billion. FX provided two points of currency headwinds here; on an FX-neutral basis, the GMS decline would have been -3% y/y.
Note that GMS contraction worsened sequentially versus Q4, which clocked in at just -1% y/y.
Revenue, however, is up 11% y/y to $641 million, beating Wall Street's more conservative $621 million (+7% y/y) expectations by a four-point margin. The revenue bridge below, however, shows the drivers behind that growth. As previously noted, the bulk of Etsy's "growth" can be explained by two factors - last April's seller fee increase to 6.5% (from a previous 5.0%), as well as leaning into seller ads.
Once Etsy starts to comp these initiatives next year, growth will largely be in line with GMS declines (as Etsy's take rate will likely stabilize around this quarter's 21% rate). To push further seller fee increases (especially at a time that buyer activity is cooling down) would risk heavily alienating Etsy's base; many of whom remember a time when seller fees sat below 5%.
It would be remiss, of course, not to mention the upside risk here: Etsy's seller fee is still below most competing marketplaces. Amazon charges between 8-15% depending on category; eBay fees also vary by category, but broadly charges 15% on the first $1,000 and 6.5% on the amount over. Etsy is still then the cheaper platform for smaller-item sales, so the company could flex its pricing power this year - but again, due to weaker GMS trends and the likelihood that many Etsy sellers are struggling to move product, another fee increase this year would be risky for the brand.
Here's some context from CFO Rachel Glaser on the Q1 earnings call on buyer trends:
Three main headwinds impacted these results. First, consumer wallet share shifts from goods to services. Second, year-over-year declines in some of our larger categories such as home and living and craft supplies. And third, pressure on consumer discretionary spending, particularly for lower household income buyers. In fact, our data supports that we have seen an impact from lower tax refunds, the ending of certain tax credits and similar items that pressure the lower household income buyers.
Double-clicking on categories for a moment. While first quarter GMS trends were weak in Home & Living there were pockets of strength in home improvement and enhancement items. We also saw solid trends in apparel, particularly in items such as tops and tees, and hoodies and sweat shirts with personalized and pop culture-related themes as well as in bags and purses and gift tag items."
And in spite of revenue growth and higher take rates, adjusted EBITDA margins still saw degradation. As shown in the chart below, the company's $170 million of adjusted EBITDA grew only 7% y/y and saw 90bps of y/y decline and 150bps of sequential deleverage, driven primarily by higher headcount in the company's product development org. The company notes that recently-acquired subsidiaries such as Depop are currently contributing -3 to -4 points of adjusted EBITDA deleverage.
Etsy adjusted EBITDA (Etsy Q1 investor presentation)
Note as well that guidance for Q2 calls for further adjusted EBITDA deleverage to "approximately 26%".
Key takeaways
I'm not sufficiently confident in Etsy's ability to grow its business beyond pandemic-era trends to remain invested in this name. With macro headwinds as well as higher costs weighing on Etsy's ability to boost its profitability, I don't think a high-teens multiple of adjusted EBITDA is warranted for this outdated e-commerce platform. Steer clear here.
For further details see:
Etsy: Appeal Is Fading Fast (Rating Downgrade)