Few stocks in the market have the growth opportunity that Etsy (NASDAQ:ETSY) does. Etsy’s online platform seems perfectly suited for what consumers today want: unique and hand-crafted rather than mass-produced and widely available. The spectacular growth Etsy stock has posted in recent years, then, seems likely to continue for some time to come.
But I backed off in January, questioning valuation at $50 per share. At $68, even after a blowout fourth quarter report in February, Etsy looks simply too expensive. There’s a great growth story here, admittedly. At this point, however, even management targets and an still-hefty out-year multiple look priced in.
Valuation Isn’t All That Matters
At the moment, ETSY trades at over 13x revenue and over 60x 2020 EPS estimates. Those multiples are big, but admittedly not terribly out of place in the current market environment.
Lyft (NASDAQ:LYFT) (another platform play, even if an obviously different one from Etsy) is unprofitable, yet commands a roughly $20 billion valuation. Match Group (NASDAQ:MTCH) is growing much more slowly – yet still receives a 9x multiple to sales, and trades at 27x 2019 EPS estimates.
What we’ve seen in the tech market of the past few years is that valuation alone doesn’t make a bear case and that a seemingly high-priced stock still can move higher. Square (NYSE:SQ) and Shopify (NYSE:SHOP) have looked overvalued for some time. SaaS (software-as-a-service) stocks seem to keep moving higher. Over the past few years, ignoring a stock simply because it’s “expensive” has proven to be a good way to miss out on big upside.
Still, ETSY is awfully expensive. Revenue growth of 37% in 2018 and an estimated 31% this year certainly seems to merit a hefty valuation. But in both years, Etsy is benefiting from fee increases, which aren’t going to happen every year. And the company’s own targets suggest that something close to perfection is priced in.
Where ETSY Goes If Management Delivers
At its Investor Day last month, Etsy detailed its five-year targets. It’s telling that Etsy Inc stock actually was a bit wobbly on the news, selling off by as much as 5% before recovering most of its losses. The outlook is strong to be sure, but the question is whether it is strong enough, especially with ETSY still not far from all-time highs.
Etsy is projecting annual GMS (gross merchandise sales) growth of 16-20%. Revenue should grow slightly faster than GMS, as Etsy’s “take rate” climbs modestly over that stretch. And Adjusted EBITDA margins are targeted to 30% or higher, up from a 23.1% print in 2018 and guidance for 23-25% this year.
Assume then, that revenue grows 19% a year, one point faster than the midpoint of GMS growth guidance. In 2023, Etsy revenue would be $1.43 billion. Adjusted EBITDA margins of 32% suggest EBITDA of $458 million.
D&A is likely to remain relatively low: it was $26.7 million in 2018, and might grow to $30 million or so. At an effective tax rate of 21%, then, net income would reach about $338 billion. The share count is going to expand owing to stock-based compensation: diluted shares rose about 4% in 2018, to 127 million. At the same rate, by 2023, the count should be about 154 million.
So management’s own targets suggest $458 million in EBITDA and about $2.20 in EPS in 2023. If Etsy Inc stock returns 8% a year until then, it would trade at $92 four years from now.
Can ETSY Stock Really Outperform?
In other words, Etsy can hit its targets, Etsy Inc stock can return a 8% a year and it’s still not enough. All that has to happen – and ETSY has to, in 2023, trade at 42x earnings and nearly 30x EBITDA.
Those are enormous multiples. And, again, this model assumes targets are met. It assumes the economy doesn’t slow down and perhaps depressing demand from some of the higher-dollar (and more profitable) items on Etsy’s site. It assumes Etsy keeps driving consistent revenue growth but starting in the second half of this year, Etsy doesn’t have the benefit of the fee hike.
Simply to get a reasonable return, basically everything has to go right for Etsy. And that, not just the high headline multiples, is the real problem for ETSY stock. It might be why the stock has settled lower since spiking after the blowout Q4 report. At a certain point, valuation prices in all of a company’s potential and Etsy Inc stock certainly seems to close to that point.
After earnings, Tim Biggam made the case for shorting ETSY and that trade actually has done reasonably well since then. I’m not quite that bearish: valuation is a poor reason to short, as tech has proven in recent years, and I do like both the Etsy business model and Etsy management.
But again, valuation matters. And this increasingly looks like a stock priced for perfection. Admittedly I thought something similar at $50, but from here, the high ETSY stock price offsets seemingly all of the optimism toward the Etsy business.
As of this writing, Vince Martin has no positions in any securities mentioned.