Shares of specialty e-retailer Etsy (NASDAQ:ETSY) had a rough 2019. The stock posted a 2019 loss of 5%, while the S&P 500 rallied nearly 30%. The major culprit for the bad 2019 performance from Etsy stock was an ugly third-quarter earnings report in late October, which included mixed third-quarter numbers and a lame fourth-quarter guide.
Investors implied from the print that the Etsy growth narrative is materially slowing. As such, they have been selling this richly-valued growth stock in droves ever since. Fortunately for bulls, calendar 2020 could be an entirely different story for Etsy stock.
Etsy’s growth narrative meaningfully slowed in 2019, as revenue growth rates decelerated and margins came under pressure. This slowing growth converged on what was the stock’s richest valuation in years, to ultimately produce significant under-performance in Etsy stock.
In 2020, though, Etsy’s growth narrative will rebound. Revenue growth rates and margins will re-accelerate higher. These favorable developments will converge on what is presently the stock’s cheapest valuation in years, to ultimately produce significant out-performance in Etsy stock.
Consequently, I like ETSY in 2020. In a sea of richly valued growth stocks that have come very far, very fast in 2019 and appear to have limited upside potential in 2020, Etsy is a notable exception on all fronts. It has the potential to out-perform in a big way over the next twelve months.
The Etsy Growth Narrative Will Rebound in 2020
On the revenue growth front, Etsy’s revenue growth rate slowed from nearly 50% exiting 2018, to sub-30% exiting 2019. This slowdown will come to an end in 2020, and revenue growth rates will stabilize in the 25- to-30% range, for a few reasons.
First, consumer spending trends in the U.S. will pick up as the economy rebounds, leading to higher e-commerce spend, and more spend through Etsy. Second, digital ad spend trends will improve with economic improvements, providing solid tailwinds for Etsy’s new ad business to gain significant traction. Third, Reverb’s take-rates should move higher as Etsy normalizes the platform’s transaction fee to match their own transaction fee.
Meanwhile, profit margins — which compressed nearly 100 basis points last quarter — should get back to expanding in 2020. Stabilizing revenue growth in the 25%-plus range will couple with moderating expense growth to drive positive operating leverage. At the same time, the ad business is particularly high-margin. As it gains traction in 2020, ad revenues should provide an upward lift to the company’s margin profile.
Broadly, then, slowing revenue growth and compressing margins at Etsy in 2019 will turn into accelerating revenue growth and expanding margins in 2020. This pivot from slowing growth to rebounding growth will provide support for a strong 2020 rally in Etsy stock.
Etsy Stock Will Run Above $50
My numbers indicate that Etsy stock has runway to levels materially above $50 in 2020.
The company has solidified its positioning as a niche specialty online retail marketplace for all things creative, where buyers and sellers from the across the globe can meet to buy and sell handmade arts and crafts goods they can’t find anywhere else (Etsy survey data indicates that 78% of Etsy buyers said they are buying products on Etsy which they can’t find anywhere else).
Sure, this market isn’t that big. But it’s still sizable, with total retail spend on these “special” products pegged at around $100 billion. Etsy owns just about 5% of this market. That’s up from 3% share in 2016. This share expansion will persist for the foreseeable future, mostly thanks to e-retail adoption tailwinds (global e-commerce spend is projected to grow at a 15%-plus pace for the next several years). As this happens, Etsy will likely sustain 15-20% revenue growth.
Over that stretch, expense growth will moderate as the company starts leveraging size and reputation to drive sales, not marketing spend. Moderating expense growth on top of sustained big revenue growth will drive positive operating leverage, and profit margins should expand.
15%-20% revenue growth on top of steady margin expansion should drive 25%-plus profit growth. Consequently, my modeling pegs Etsy’s 2025 earnings per share potential at roughly $3.50. Based on a consumer discretionary sector-average 22-times forward earnings multiple, that implies a 2024 price target for Etsy stock of $77. Discounted back by 10% pear year, that equates to a 2020 price target of almost $53.
Bottom Line on ETSY Stock
The 2020 bull thesis on Etsy stock is pretty simple.
Etsy stock didn’t have a good 2019. This under-performance positions the stock to have a good 2020. The things which hurt Etsy stock in 2019 will reverse course in 2020. That is, revenue growth rates will stabilize and margins will rebound.
These favorable reversals will converge on Etsy’s cheapest valuation in years. That convergence will spark a big 2020 rally in Etsy stock.
As of this writing, Luke Lango was long ETSY.
