2023-07-21 12:59:47 ET
Summary
- Etsy's stock has underperformed this year, with shares down nearly 18% despite the company generating results in line with its guidance for Q1 2023.
- The company's revenue growth has declined significantly, possibly indicating market saturation, and it has taken on increasing levels of debt over the past two years.
- Despite these challenges, Etsy has remained cash flow generative and generally profitable, although its recent quarters point to it holding steady and not indicating faster growth or materially increased profits.
- Considering all of this, Etsy stock is a hold until we can identify a clearer direction for the company.
Overview
Etsy ( ETSY ) stock has not had a good run this year. Starting off fairly strong and outpacing both the NASDAQ Composite as well as the S&P 500, Etsy saw its shares sell-off immediately prior to and after its Q4 2022 earnings report. Since then, the stock's price return has continued to trail both indices and is down close to 18% for the year. It has materially underperformed the Consumer Discretionary sector at large, indexed here through the XLY ETF.
Surprisingly, this depreciation has not reversed even as the company was able to generate results that were in line with its guidance for the latest quarter, Q1 2023. Now slated to release its Q2 2023 earnings report in two weeks' time, it is worth looking into Etsy's fundamentals to see how it may perform. In this article, I'll review the company's financials from both a bird's eye view (long-term) as well as select metrics that may be more salient for its quarterly print ahead.
Long-Term Fundamentals
Etsy has been trading publicly since Q2 2015, providing us with a decade's worth of financials for review. Starting with a look at its topline, we can see that Etsy has grown significantly throughout the last ten years. This growth has been highly volatile but quite robust overall, noticeably posting standout triple-digit growth during the 2020 pandemic year. Having returned to historical rates of growth thereafter, Etsy has since posted its weakest year of revenue growth for fiscal year 2022 - 10.2%. This amounts to a significant decline from the company's long-term growth rates and is less than half of what was the previous low for the firm's revenue growth (2017).
This kind of revenue decline is never good to see and could signal that Etsy has achieved saturation in its target market. It is quite likely a major driver of the stock selling off throughout this year, having lost a portion of its growth premium and trading at a lower multiple due to more pessimistic forward prospects. Since this is still very much a growth stock, it will be important to investigate its revenue trendline in more granular detail within the next section.
Moving on to profitability, we see a similar trajectory. Last year's significantly negative net income figure of $694M was due to one-off expenses of $662M. This stemmed from Etsy sustaining a non-cash impairment charge of $949M in Q3 2022, during which the company wrote down the full amount of its goodwill for two of its prior acquisitions (Depop and Elo7). Net income for 2022 would have still been roughly -$32M, but the picture is certainly not as bad as it may appear.
Continuing on to cash flow, we can see that Etsy has been generating positive cash from operations throughout the last decade and is continuing to do so. This figure appears to be holding steady over the last 3 years, with a slight decline from 2020-2021 and a subsequent return to 2020 levels last year. This amounted to a healthy cash operating margin of 26.63% for 2022.
Finishing up with the balance sheet, it is clear that Etsy is on a trendline of generally increasing levels of debt. While it had a negative net debt figure as recently as 2020, it has taken on significant obligations over the last two years and was holding $2.43B of debt as of the end of last year. While I wouldn't consider this to be a particularly worrisome level of debt for a company of this size, I am still keen to see exactly what kind of return Etsy is getting on this borrowed capital in recent quarters.
Overall, these financials tell the story of a fast-growing company that has been consistently cash-flow generative as well as generally profitable - albeit with a much more worrisome recent trend. While I consider the company's overall financial performance to be commendable over the past decade, the question here is evidently whether it can bring itself back to historical levels of growth or if it is now in a slower-growth phase. This will be made more clear by looking at its performance in recent quarters specifically.
Recent Quarterly Fundamentals
With that long-term trendline ascertained, we can look into Etsy's recent quarters to see how persistent it may really be.
As to top-line growth, it appears that Etsy is indeed in a sustained rough patch. The last 7 quarters have all seen the company post growth rates well below its historical average, and there has not been a quarter indicating that this trend is temporary. For now, it appears that low double-digit growth is the new norm.
This is also reflected in net income, which is down y/y for the last 5 quarters. Even if we discount the aberrant quarter in which the firm wrote down its prior acquisitions, this does not look particularly good. Even as revenues have continued to grow, albeit more slowly, net income has declined over recent periods.
This indicates that Etsy's cost structure is growing at a faster rate than its revenues, something we can readily confirm by looking at its operating expenses. Last quarter appears to have shown a normalization of SG&A expense as well as R&D expense, which nonetheless remains high. This level of growth in R&D spend indicates to me that management considers the company to still be in growth mode. What I would be keen to see is for overall operating expense growth to come closer to that of revenue, which should stabilize margins. Nonetheless, the company appears to be heading in the right direction as of last quarter.
As to cash from operations, things appear to be holding steady. The last 2 quarters saw Etsy generate cash from operations that were roughly flat y/y.
This is also reflected in the firm's free cash flow, which has been cyclical but holding roughly at parity y/y in recent periods. We can quickly note that the company's cash flow generation has been significantly less volatile than the stock overall, indicating a cheaper cash valuation relative to higher price points that the stock was trading at throughout 2021-2022.
Considering these recent quarters, I think it's fair to say that Etsy is in a holding pattern. It is holding steady across its core metrics but has not yet made significant improvements to them. The question with this stock is what's next. Etsy could see its shares buoyed by a return to higher revenue growth or through a focus on profitability and cash flow. Either would be good for the stock, but a lack of discernible progress in either direction will likely see shares maintain their current anemic state.
Valuation
Etsy continues to trade as a growth stock, with a non-GAAP trailing P/E of 23.3 and a forward P/E of 22.5. This amounts to a significant premium as compared to both the consumer discretionary sector as well as the information technology sector. It is nonetheless trading at a cheap forward P/E relative to where it has been over the last few years. This creates an upside case for the firm's shares in case it can reclaim future growth expectations for revenues or earnings.
Forward Outlook and Risk Profile
The unfortunate reality is that Etsy has been left behind by what has been a well-performing consumer discretionary sector overall this year. I believe that this is likely due to the nature of Etsy's business. As a marketplace for individual craftspeople as well as small businesses making bespoke goods, it appears that they have been more affected by consumer uncertainty than others.
Essentially, Etsy is not in the business of selling the essentials. Their business is focused on enabling sellers of handmade goods, which are often decorative or otherwise not particularly useful. I am not surprised that consumers are relatively less keen on these types of goods in the current economic context, which is reflected in slowing growth rates for Etsy as well as a lack of action in its stock.
This could be exacerbated by additional economic volatility. While consumer spending has remained fairly strong, a decline there would see additional pressure on Etsy's business.
The other factor to consider is the split between goods and services spending. Etsy's revenues boomed during the 2020 pandemic year as consumers were limited in their selection of services and concentrated on purchasing goods. This trend has now been reversing itself, and a relatively higher preference for services spending - such as travel - will likely continue to play out for the next two quarters.
Conclusion
Overall, the macroeconomic environment is creating a relatively high amount of uncertainty for Etsy's business in particular, given its economic positioning. Additionally, Etsy does not appear to be demonstrating a clear path to increasing profitability. This results in a state in which it is growing more slowly than before, without counterbalancing this through bottom line expansion. Taken together, this yields a hold rating for Etsy while we await further signals regarding the direction of its business.
For further details see:
Etsy: Holding Steady, But No Reason To Buy Yet