Summary
- Etsy's stock is up 107% from its 52-week low, and this sudden increase has investors questioning whether the worst is over.
- In the third quarter, the company had fewer active buyers and sellers than it did in the prior year.
- Etsy overpaid for Depop and Elo7 and many may argue that the management team lacks the necessary skill set when it comes to capital allocation.
- The primary factor in favor of an optimistic outlook on Etsy is the degree to which its offering is differentiated from that of its competitors and its network effect.
- The anticipated growth has already been more than fully priced into the stock price, let alone the numerous things that could go wrong along the way.
Investment Thesis
During the worst of the pandemic, when brick-and-mortar stores were generally closed, Etsy ( ETSY ) was a stock market favorite. Despite a rise over the previous few months, the stock fell 45% last year after rising more than 300% in 2020 and 23% in 2021. Due in part to the macroeconomic environment, the well-known online marketplace for one-of-a-kind, vintage, and handcrafted goods is experiencing a considerable slowdown.
Etsy's stock has fallen 53% from its peak. It is, however, up 107% from its 52-week low. This sudden increase in the stock price has investors questioning whether the worst is over.
The foundations of Etsy may appear strong enough for a decent long-term investment, but it is having trouble expanding. The latter problem can reduce the company's stockholders' long and short-term returns.
The Growth Is Missing
Many investors believe that Etsy was mainly a pandemic bet and that its heyday is past, and they are not completely wrong. It's probably safe to assume that Etsy's growth won't be as stunning in the future. In fact, recent quarters have seen a standstill in e-commerce sales in the United States as a share of total retail sales.
And this pattern may be reflected in the user base of Etsy . It has never happened before, yet in the third quarter, there were fewer active buyers and sellers than there were in the prior year. Perhaps this is a return to normalcy after the pandemic-driven boom. Or perhaps it's a warning that Etsy's days of quick growth are coming to an end.
When you take into account that the published numbers also include Etsy's other markets, a declining user base becomes even more concerning. The number of active users decreased even after the integration of more recent specialized marketplaces.
news.depop.com
elo7.com.br
Two of the additional markets, Depop and Elo7 , were purchased by Etsy in 2021 for a total of $1.8 billion. In the most recent quarter, these purchases had to be written down, causing a $1 billion impairment charge.
As is clearly evident from the fact that Etsy substantially overpaid for Depop and Elo7, detractors may argue that the management team, led by CEO Josh Silverman, lacks the necessary skill set when it comes to capital allocation.
Thankfully, that burden is now behind Etsy, allowing it to concentrate on expanding its smaller platforms. In an effort to expand Depop and Elo7, management is utilizing what it has learned from running Etsy, particularly its search engines.
Despite this, the company will struggle to grow in 2023. The combined merchandise volume of its Depop, Elo7, and Reverb platforms is much less than the net sales volume on the Etsy platform. Therefore, even if Etsy were able to spur growth in these other markets, the impact on the company as a whole would be minimal.
Etsy's growth has slowed in 2022, as has been noticed. The management said that in October, trends had improved. However, it continued to give sales guidance for the fourth quarter of only $700 million to $800 million. Putting things into perspective, this suggests that revenue may have decreased from the $717 million recorded in the fourth quarter of 2021.
Poor Future And Valuation
If we take a step back, we can see how outstanding Etsy's performance has been over a longer period of time. The price of Etsy's shares has increased by more than 630% in the last five years.
However, it's possible that the upcoming years won't be exactly like the previous ones, so shareholders should keep this in mind. The e-commerce and handicrafts markets are expected to expand at a CAGR of approximately 9%, according to analysts. This suggests that Etsy will organically expand by single digits if it maintains its market share, which is substantially less than what the company's current valuation implies for the future and what its shareholders are used to.
Furthermore, a significant danger is posed by the potential for a short-term recession. Customers can put off purchasing discretionary items from Etsy's markets when times are rough and their budgets are stretched thin. Additionally, in a recessionary environment, it will be challenging to stimulate recurrent buying behavior.
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Even investors who are able to see beyond the near-term uncertainty and concentrate on the coming years might not find the company to be an attractive investment right now. Etsy is trading at 7.16 P/S and almost 32 P/E, while the sectors' medians are 0.93 and 11.61, respectively. The anticipated growth has already been more than fully priced into the stock price, let alone the numerous things that could go wrong along the way, even if a recession does not happen or if the company survives it and gets stronger.
Risks To Thesis
Differentiation
I would suggest that the primary factor in favor of an optimistic outlook on Etsy is the degree to which its offering is differentiated from that of its competitors.
Having more than three times as many repeat customers as it had just three years ago may be partially explained by the fact that it provides distinctive products. This shields it from the threat posed by an online retail giant such as Amazon ( AMZN ).
The Network Effect
In addition, Etsy enjoys a competitive advantage known as the "network effect," which benefits the company immensely. This essentially indicates that the value that the platform provides to its consumers will increase as the platform's user base grows.
Etsy sellers are seeing an increase in their consumer base as a growing number of buyers are turning to the platform for their shopping needs. Additionally, as more sellers open up shop and make their wares available on Etsy, buyers are presented with a greater variety of options from which to choose when making a purchase.
Because of network effects, it is more difficult for competitors to differentiate themselves from the crowd. This creates a positive feedback cycle in which growth feeds growth.
This helps to explain Etsy's exceptional performance over the past few years, even though the company is currently experiencing a slowdown as a result of challenging comparisons to the previous year and a general macroeconomic downturn, and reassures many investors that the company is here to stay.
Conclusion
In summary, despite the recent dip, Etsy's growth and profitability over the years have been amazing. But investors should think of these profits as historical. The number of users on Etsy has stopped growing, and the website may see some short-term difficulties, particularly if there is a recession. I don't think the firm will disappear, but I do think it is still overhyped. Many investors will be shocked to discover that future growth will be significantly less than 20%–30% and that the company's potential future prospects do not justify the premium that it is currently trading at.
For further details see:
Etsy: Its Prime Has Passed