Trading On margin

Etsy Inventory: Don’t Buy During the Downturn (NASDAQ: ETSY)

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When investing and selecting stocks in this volatile market, caution is advised. I prefer to invest massively in outdated stocks, but those whose fundamentals are also irreproachable. There are a number of tech stocks this year that are down on sentiment alone and saw huge compressions in valuation – I would lean on those “reasonably priced growth” stocks to play the rebound.

Etsy (NASDAQ: ETSY), on the other hand, has collapsed significantly this year – but at the same time, its finances don’t look so healthy. Like many other e-commerce businesses, Etsy has received a big boost during the pandemic, but now, at the end of 2022, with full normalization almost fully set in, those tailwinds seem very ad hoc in nature. .

Since the start of the year, shares of Etsy have fallen almost 50%. This has many investors hooked on the idea of ​​buying Etsy at a huge discount – but I think Etsy’s current valuation, compared to its current demand headwinds, is already quite appropriate.

Chart
ETSY data by YCharts

I’m staying neutral on Etsy and continue to see stock as a mix of positives and negatives.

On the bright side for Etsy:

  • Etsy has proven itself distinct from Amazon (AMZN). While Amazon has its roots in being the “everything” store that many consumers make targeted, price-conscious buying decisions for, Etsy has amassed a unique offering of products for users to browse and purchase. . Its dominance in certain categories, like crafts, jewelry, and home goods, gives it an edge over generalists like Amazon.
  • Profit margins remained high. Thanks in large part to increases in the company’s referral fees (which, at 6.5%, are still somewhat lower than Amazon and eBay (EBAY) referral fees), Etsy has managed to retain a adjusted EBITDA margin of around 30%. Enthusiasm for Etsy’s profitability is what helped spark a bear market rally in the stock in July, although I think there’s still a long way to go before Etsy can be rated on the basis of Adjusted EBITDA or any earnings measure alone.

At the same time, however, we need to be aware of the risks:

  • Slowdown in demand. We’ve seen many indicators of slowing Etsy demand, including a contraction in GMV, losses in the active buyer base, and a slowdown in new buyer acquisition. Consumers are tightening their belts and, globally, unfavorable exchange rates are also contributing to dampen consumer spending.
  • Unfavorable macro. However, it’s not just the stronger dollar – the pandemic-era boom in moves to new homes is experiencing a drastic cooling, impacting Etsy’s largest category – furniture and accessories. household items. In my view, these downside catalysts have no short-term remedy.

Also, Etsy’s valuation can no longer be considered truly cheap either. At the current stock price near $110, Etsy has a market capitalization of $13.98 billion. After offsetting $1.05 billion in cash and $2.28 billion in debt on Etsy’s most recent balance sheet, the company results the enterprise value is $15.20 billion.

Compared to Wall Street’s FY22 revenue outlook of $2.77 billion (+12% YoY; Yahoo Finance data), meanwhile, Etsy is trading at 5.5x EV/FY23 turnover – which I think is a high multiple for a company currently with almost zero GMS growth. Remember that most of Etsy’s current revenue growth is due to an increase in seller fees (which provides a one-time boost to growth, but cannot be repeated indefinitely). There are plenty of other tech stocks in the market that are trading in the 20-30% range and are currently trading at multiples similar to Etsy.

Continue to deploy a watch and wait attitude here: I don’t see the benefit of rushing to buy Etsy at current levels.

Download Q2

Let’s now highlight some of the risks that surfaced in Etsy’s second quarter results, starting with revenue and GMS trends:

Etsy/GMS revenue

Etsy/GMS revenue (Etsy Q2 Results Tray)

Etsy’s second quarter revenue increased 11% year-on-year to $585.1 million in the quarter, and as previously reported, this revenue growth was primarily driven by increased selling expenses from 5.0% to 6.5%, which was enacted in April. This is also reflected in the increase in the company’s participation rate to 19.3%, almost two points higher than 17.4% in the year-ago quarter. Another “unnatural” revenue benefit from a y/a compensation perspective is the acquisitions of Depop and Elo7, which had no revenue contribution in the second quarter of last year.

GMS underlying growth, meanwhile, contracted -0.4% year-on-year to $3.03 billion. Now there were three currency impact points here. On a currency-neutral basis, Etsy’s GMS would have grown 2.6% year-over-year. That being said, however, the company has experienced a significant deceleration, regardless of currency impacts. Even on a currency-neutral basis, GMS growth would have slowed 220 basis points to 4.8% y/y in Q1 and 16.9% y/y in Q2.

Trend Etsy GMS

Trend Etsy GMS (Etsy Q2 Results Tray)

The weakness of the categories lifted by the pandemic is part of the driving force here. As previously reported, Etsy and other home goods companies like Restoration Hardware (RH) and Wayfair (W) have experienced a huge boom during the pandemic as a national craze swept across the United States. Now, that is no longer the case with companies calling workers back to the office and with home buying in a lockdown period with rising interest rates, these categories are experiencing a huge cooling. As shown in the chart below, the home and accommodation category – accounting for 30% of Etsy’s GMS and its largest category – saw double-digit year-over-year declines. Interestingly, crafting supplies also saw a similar decline and are also the weakest category from a three-year stack perspective – perhaps a reflection of weaker free time at home in the industry. post-pandemic era.

Etsy GMS by Category

Etsy GMS by category (Etsy Q2 Results Tray)

Also in the second quarter, Etsy’s active buyer base dropped 1 million buyers to 88.1 million; the second consecutive quarter of sequential decline. Habitual and regular buyers have also decreased:

Etsy Buyer Base

Etsy Buyer Base (Etsy Q2 Results Tray)

The acquisition of new buyers is also weak. The 6.4 million new buyers added in the second quarter marks the worst quarter for customer additions in three years, although the company still notes new buyer trends are above the pre-COVID baseline:

Acquiring a New Etsy Shopper

Acquiring a New Etsy Shopper (Etsy Q2 Results Tray)

A “saving grace” for Etsy is that the company still managed to maintain a pro forma adjusted EBITDA margin of 28%, up two points year-on-year from 26% in the second quarter of the previous year. However, this is lower than the FY20 and FY21 margins above 30%.

Etsy's Adjusted EBITDA

Etsy’s Adjusted EBITDA (Etsy Q2 Results Tray)

Acquisitions presented a headwind here of 400 basis points. In Etsy’s rush to increase its category’s appeal, the company has taken on unprofitable affiliates that are also performing below expectations in the current macro environment. As CFO Rachel Glaser remarked on the second quarter earnings call:

Our three subsidiaries were a headwind of more than 400 basis points for our consolidated adjusted EBITDA margin, with Depop being the main drag. We are confident that the strategic rationale for acquiring Depop and Elo7 is strong, giving us access to the large resale apparel market and opening up an untapped market opportunity in Brazil.

It’s also fair to say that given the current significant macroeconomic headwinds, both companies have so far performed below the financial expectations we had a year ago.”

Key points to remember

With GMS’s slowing organic growth, declining profitability due to underperforming acquisitions, and a debt-laden balance sheet on top of a reasonably rich valuation, I see no reason to be excited about Etsy at this time. . Stay away until the stock price drops further.