E-commerce platform Etsy Inc (NASDAQ:ETSY) is set to report first-quarter earnings after the bell on Tuesday, and as the past has proven, Etsy investors are prone to hair-trigger reactions. A dismal Q4 report sent shares spiraling 25% in just a couple weeks. And while ETSY stock has slowly climbed back up to the $11 area, it feels very much like a dead-cat bounce.
I say fade the rally. Here’s why.
Etsy Earnings Won’t Be Pretty
My research indicates Etsy had trouble driving traffic to its site over the past several months.
Web traffic analytics site SimilarWeb gives mixed results on Etsy.com traffic. The site’s popularity is trending down domestically, but holding stable among shopping websites. Fellow web traffic analytics site Alexa, though, gives a strong negative read on Etsy.com traffic. According to Alexa, Etsy.com’s popularity has trended down sharply over the past several months, and is down big year-over-year.
Search interest data corroborates the bearish data from Alexa. Search interest related to Etsy has fallen roughly 2% so far in 2017. That compares to roughly flat growth in the last 3 months of 2016.
It also makes me worry that insiders don’t like ETSY stock. There has been a tremendous amount of insider selling over the past 12 months. Specifically, over the past three months, insiders haven’t bought a single share but have unloaded more than 100,00 shares.
All in all, there isn’t much evidence that Etsy had a great quarter.
Long-Term Growth Is At Risk
In the bigger picture, the Etsy growth story is starting to show cracks.
Etsy doesn’t really have a competitive moat against Amazon.com, Inc. (NASDAQ:AMZN). Amazon has a size and reach advantage (Amazon is a far bigger marketplace that Etsy), a price advantage (free shipping perks) and a resource advantage (Amazon has a much bigger balance sheet and much larger cash flows). This is showing in the numbers. Amazon just reported very strong retail sales growth. Etsy, meanwhile, looks like it struggled over the past several months.
The Etsy revenue growth story is also out of whack. Big revenue growth numbers are being driven by out-sized Seller Services’ growth. In the near-term, that is sustainable due to scale. Seller Services revenue is just beginning to ramp and still represents a small fraction of Gross Merchandise Sales, or GMS.
In the long-term, though, out-sized Seller Services’ growth isn’t sustainable. Sellers need to see ROI, so once at scale, Seller Services growth and GMS growth should go relatively hand in hand on a dollar basis.
GMS growth is only slowing, so that means Seller Services growth will inevitably come down sharply. That is a big problem when management is guiding for a 23% to 25% compounded revenue growth rate into 2018.
Bottom Line on ETSY Stock
ETSY stock is not cheap, trading at 50 times next year’s consensus earnings estimate. And maybe it deserves such a multiple, considering how excited Wall Street will be to actually get a profit out of Etsy this year (analysts expect a 3-cent profit this year, then a 22-cent profit in 2018, after a 26-cent loss in 2016).
Assuming around 120 million fully diluted shares in 2018, we can back out that 22-cent consensus EPS estimate to a $26.4 million in net profit. Consensus revenue estimate for that sits around $530 million, so that is a 5% net profit margin. But as I said earlier, 20% compounded growth on the top line is too high for ETSY, whose growth is slowing dramatically. More realistically, revenues grow around 10% in 2017 and 2018. That puts 2018 revenue at $440 million.
Without revenue scale, profit margins will not get to 5%. A 3% profit margin on 120 million diluted shares would lead to EPS of 11 cents. So really, ETSY stock trades at 100 times forward P/E.
That figure is entirely too expensive for a company with as many operational risks as Etsy. But if the quarter ends up being as challenging as my research indicates, maybe that P/E will come down … on a big drop in ETSY stock.
I already don’t like Etsy’s rich valuation, but if the company posts another shaky quarter, get out — quick!
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
