Shares of online DIY marketplace Etsy (NASDAQ:ETSY) exploded higher after the company delivered a robust double-beat-and-raise third quarter earnings report on Tuesday, 11/6. Those strong numbers underscored the long-term bull thesis for ETSY stock, and consequently propelled shares 25% higher.
But, while the quarter was really good and the Etsy growth narrative is only improving, valuation is a big concern for this stock.
ETSY stock is now above $50. The stock has peaked above $50 three times before. Each time, the rally didn’t last. Not because the fundamentals suddenly deteriorated when ETSY stock jumped above $50. Rather, because even aggressive and optimistic long-term growth assumptions don’t support ETSY stock at $50 just yet.
Thus, while Etsy features a compelling long-term growth narrative and is a long-term winning investment, prices above $50 are simply premature. I wouldn’t chase the rally. Instead, I would wait for the rally to cool off, and then buy the dip.
Long-Term Growth Fundamentals Are Strong, & Only Improving
Etsy’s Q3 numbers affirmed one exceptionally bullish overarching theme for the company: Etsy’s growth fundamentals are improving at the same time that growth fundamentals at Amazon (NASDAQ:AMZN) e-commerce are deteriorating. This theme implies that Etsy has successfully fought off the Amazon threat, and is a lock for 20%-plus revenue growth going forward.
For a long time, the biggest knock against ETSY stock was that it doesn’t deserve its valuation because of inevitable “Amazonification”. Eventually, Amazon would copy exactly what Etsy does. Amazon would replicate the model with greater scale, and do it at lower prices. Sellers would quickly leave Etsy. Buyers would follow suit. The whole Etsy platform would collapse, and ETSY stock would drop.
That hasn’t happened.
Instead, Amazon’s e-commerce business has cooled. In particular, the company’s third-party services growth rate has cooled from 40% and up a few quarters ago, to 30% and slowing last quarter. Meanwhile, during that stretch, gross merchandise sales growth on Etsy has accelerated for five consecutive quarters, and registered at a multi-quarter high of over 20% in Q3.
Thus, while Amazon’s third-party e-commerce growth has cooled, Etsy’s gross merchandise sales growth has accelerated.
This acceleration has happened despite Etsy upping its transaction rate during the process from 3.5% to 5%. Naturally, one would expect seller churn as a result of this rate hike. Instead, seller growth has maintained its high single digit pace. Meanwhile, buyer growth has actually accelerated, and gross merchandise sales per active buyer growth has gone from slightly negative to positive over the past year.
Overall, the whole Etsy growth narrative is improving. This shouldn’t be a shock. Etsy has clearly established a niche for itself as a trusted digital marketplace for the buying and selling of handmade arts and crafts. Amazon has tried to penetrate this market. But, they haven’t had great success. Now, Amazon’s growth is slowing. Etsy’s growth is ramping. Ultimately, that means this company has healthy and improving long-term growth fundamentals.
A $50 Price Tag Is Premature
Those healthy and improving growth fundamentals are already full priced into shares at current levels.
This is a company with $3 billion in gross merchandise sales attacking a $1.3 trillion market that comprises global spend on things like clothing, accessories, home, living, jewelry, craft supplies, and more. Moreover, competition risks have been muted thanks to GMS acceleration concurrent to Amazon e-commerce growth deceleration. Price hike related churn risks have likewise been muted thanks to robust seller growth concurrent to a big transaction rate increase.
Thus, considering the company’s small market share in a huge addressable market and the lack of top-line growth obstacles in the foreseeable future, Etsy promises to be a big revenue growth company for a lot longer. Revenue growth this year is running around 30%-plus. But, that is mostly because of the transaction rate increase. Long term, revenue growth will normalize back to GMS growth, which has run around 20% for the past few quarters.
So after this year, revenue growth should normalize back to 20%. Assuming revenues hit $600 million this year, a 20% compounded annual growth rate thereafter implies fiscal 2023 revenues of roughly $1.5 billion. During that stretch, gross and EBITDA margins should continue to improve thanks to favorable pricing, heavier volume buying from consumers, and opex leverage. A 30% operating margin seems like a fair and reasonable target by fiscal 2023.
Under those fairly optimistic growth assumptions, I think EPS shakes out around $2.30 in fiscal 2023. That just isn’t enough earnings power to warrant a $50 price tag today. Even if you assume ETSY stock gets a huge-growth 30 forward multiple in five years, that implies a $69 price target by fiscal 2022 end. Discounted back by 10% per year, you are looking at a fiscal 2018 end price target of under $50.
Thus, a $50 price tag today for ETSY stock seems premature.
Bottom Line on ETSY Stock
ETSY stock is a long-term winner that is slightly out over its skis at the present moment. Chasing this rally seems unnecessarily risky. Rather, the smart move seems to be to wait for the rally to cool off, and buy on dips below $50.
As of this writing, Luke Lango was long AMZN, and may initiate a long position in ETSY within the next 72 hours.