When Etsy, Inc. (NASDAQ:ETSY) shares dipped to a three-year low last week, Wolfe Research decided it was time for an upgrade.
On September 12th, the sell-side research firm bumped its rating on the creative goods retailer from Peer Perform to Outperform and gave it a $100 price target. The reason: Etsy has lagged the Nasdaq market so badly that it's bound to reverse. But is it?
While the Nasdaq flirts with a fresh all-time high, Etsy’s 46% year-to-date slide stems from several issues. The absence of pandemic stay-at-home restrictions that drove extreme growth in 2020-2021 is only part of the story. And a broader e-commerce slowdown at the hands of sticky inflation is more than just an Etsy problem.
The reality is Etsy faces far more competition than it did a few years ago. The company’s lockdown success along with rising consumer interest in one-of-a-kind merchandise, is attracting online giants such as Amazon and eBay. Social media leaders Facebook and TikTok are harnessing the power of peer influence and shoppable content by building out their own creative marketplaces. Toss in emerging home goods e-tailers like Wayfair and Overstock, and Etsy is no longer the only show in town for artsy merchants and buyers.
To Etsy’s credit, it has handled the competitive threat quite well. Revenue continues to grow off an enormous 2020 base. Active buyers and sellers were up last quarter as were reactivated buyers. Unfortunately, marketing and investments in new tools to fend off competitors comes at the expense of lower profits. Analysts are projecting that earnings per share (EPS) will decline at least 20% for the second straight year in 2023.
But as Wall Street bulls point out, this is expected to set the stage for a return to profit growth in 2024 when Etsy’s sales are forecast to reach $3 billion and spending cools. Wolfe Research may be getting ahead of the game. Etsy’s first upgrade in more than 12 months may turn out to be a crafty buy signal.
What Is Etsy’s Growth Outlook?
The consensus estimate for Etsy’s 2024 EPS is $2.83. This implies 16.5% growth from what’s expected for this year. How will it get there?
For starters, both marketplace and services revenue must continue to grow as they did in the second quarter. Marketplace, which accounts for more than 70% of sales, will have to keep acquiring new buyers through marketing campaigns and international expansion. If Etsy can continue to offer sellers value with shiny new tools, further seller fee hikes may be justifiable. On the services side of the business, a healthier digital advertising market would go a long way in offsetting marketplace fluctuations — especially outside of the key holiday shopping period. If these catalysts fall into place, Etsy’s top line growth should accelerate next year.
Still, to generate even stronger bottom line growth, some serious work will be needed on the expense side of the ledger. A wind down of technology investments should help but more is required. The key battleground to watch is management’s ability to rein in marketing costs while maintaining user growth. If successful on this front, the path to double-digit EPS growth gets clearer.
Is Etsy’s Stock Undervalued?
Etsy jumped more than 3% to $66.68 on September 14th due to the Wolfe upgrade. Most of the gains, however, were erased the next day when the high beta name got targeted in Friday’s Nasdaq selloff.
This means the stock entered this week at $64.94, a whopping 79% below its 2021 peak. It also means that it trades around 23x next year’s earnings estimate. During its 2021 run above $300, Etsy’s P/E ratio was above 50x. Amazon is trading at 45x next year’s earnings but has a booming cloud business that Etsy does not.
Either way, you look at it, a 50% discount is tempting but may be appropriate because Etsy isn’t growing like it once was. To attract investors and, more importantly, institutional investors, the company will need to show that it is back on a path of sustainable profit growth. This could make 2024 a ‘make or break’ execution year.
Etsy is probably undervalued at this point, but may go sideways for the rest of the year. The market will want to see the fundamentals improve before jumping on last week’s upgrade. But with more than 50% upside to $100, the stock could carve out some big gains in 2024.
