Will Etsy Stock Bounce Back?

Consumer cyclical online retailer Etsy, Inc. (NASDAQ:ETSY) has carved out a niche for itself in the e-commerce space that is dominated by some big juggernauts thanks to its marketplace of unique and vintage goods that are hard to come by.

Following a stellar pandemic performance when loose monetary policy and demand spiked for masks, Etsy has tumbled back down to earth.

Down almost 80% in just a few short years, what are the odds that this arts and crafts marketplace will make a return to former glories?

The Trials and Tribulations at Etsy

Etsy’s platform capitalized on 2020-21 demand by actively mobilizing sellers. In the same month the CDC guidelines were declared, the company sold more than 12 million masks, which generated $133 million in gross merchandise value, representing about 17% of the marketplace’s total sales. Moreover, the company’s GMS more than doubled itself between 2019 and 2020.

Investors also reaped the benefits as the stock soared by almost 300% between 2020 and 2021. Just for context, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) gained only about 16% during the same time, while e-commerce leader Amazon.com, Inc. (NASDAQ:AMZN) returned over 70%.

However, this mask-fueled rapid growth proved to be unsustainable and soon tighter monetary policy was enacted to counter the effects of inflation.

Between 2021 and 2022, the company saw a drop in active buyer and active seller counts, while GMS also fell by 1.3%. This continued last year as well, when GMS declined by another 1.2% to reach $13.16 billion. As financials disappointed, the share price fell substantially.

In the latest quarterly report (Q1 ended March 31), GMS contracted by 3.7% from the prior year’s period to $2.99 billion. 

Of notable concern is the fact that active sellers increased by 15% year-over-year while active buyers only expanded marginally. 

Can Etsy Reach the Heights Again?

Etsy has a capital-light operating structure, which has historically led to a strong balance sheet and solid cash flows.

The niche in which it plays has produced a competitive advantage because it’s widely regarded as a brand leader and the go-to place to buy and sell arts and crafts online. The platform is well-known to offer items that are difficult to find on other marketplaces.

It’s also succeeded in building a marketplace model well, by scaling both the demand and supply side simultaneously but for all its successes, concerns are rife that the market may be saturated.

Morgan Stanley analysts Nathan Feather and Brian Nowak downgraded Etsy from “equal weight” to “underweight” and also cut its price target from $64 to $55, citing saturation worries. 

If management attempts to solve this hurdle through higher marketing spending, a natural consequence will be lower margins.

For now, management is trying to gain back lost ground through a restructuring plan to streamline costs through a lay off 11% of the workforce.

And while cutting costs has formed one part of the plan to solidify the financials, growing the top line is another key part of the strategy. On that front, Etsy’s “Gift Mode” offering was rolled out last quarter. So too has the team worked on fraud detection to boost consumer trust when buying.

In addition, the firm’s 2019-initiated “Right to Win” plan is still ongoing and aims to boost big-ticket purchases as well as frequency.

Over the long-term the plan is to grow annual GMS in the range of 16%-20%. However, looking at the current annual GMS, it’s far from the vision as of now.

Will Etsy Stock Recover?

Analysts forecast that Etsy stock will recover to $70 per share as a result of new cost-cutting measures and revenue growth initiatives.

While the fall in GMS and possible market saturation are concerning, Etsy has a moat in the form of a brand advantage as the go-to place for everything from knitting designs to craft pottery.

Clearly management has assessed that the share price is undervalued relative to fair value and put in place a share buyback scheme that signals good things to come for shareholders.

Notably, the company has reported high gross margins consistently which lends itself to financial flexibility. For many quarters now consecutively, gross margin has been in or around the 70% mark.

The company also enjoys over $1 billion of cash and short-term investments on the books against $2.2 billion of debt, not an especially concerning ratio.

Now trading at 14.97x forward earnings, the valuation does seem a little bit stretched by industry standards but sits well below the five-year average of 42.89x.

With an expected long-term (3-5 years) earnings per share growth at a CAGR of 9.6%, its PEG sits at 1.55, suggesting it’s climbing towards overvaluation levels.

Perhaps of greatest note is the fact that a discounted cash flow forecast paints a more rosy picture than analysts are giving the company credit for. If a DCF is to be believed, Etsy has upside potential to $81 per share, suggesting as much as 34.6% upside opportunity.

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