E-commerce platform Etsy (ETSY 5.53%) has built something special in the retail sector. It's website, which focuses on the sale of handmade or vintage items and craft supplies, has taken that feeling of stumbling onto that unique store you found on vacation and blown it up on a massive scale, and it's attracting buyers and sellers like a magnet.
Stock in the company has risen sharply in 2020, as growth exploded following the onset of the COVID-19 pandemic. But there are three reasons why shares have more room to climb.
1. Product breadth driving growth
Etsy's revenue soared 137% year over year last quarter. Growth will likely moderate as more stores get back to normal operations, but even before the pandemic began, the company was growing revenue above 30%.
Etsy's platform is built around sophisticated search-and-discovery technology, which is a key strategy to make the marketplace easier to browse. There were 65 million items listed on the site in 2019, and Etsy ended the second quarter with 3.1 million active sellers, an increase of 35% year over year.
As more sellers gravitate to the platform, and the number of listings increases, Etsy is becoming like a treasure hunt for buyers. But it's also a place where buyers go shopping for specific items. Etsy sellers sold $346 million worth of face masks in the second quarter. That's more than 10% of the company's total gross merchandise sales.
Excluding face masks, sales still grew 93% last quarter. The top-selling categories were home furnishings, jewelry, craft supplies, and apparel. The slowest-growing category was apparel, which nonetheless saw sales rise by an impressive 59% year over year.
These are large retail categories that Etsy is starting to penetrate. There are not many retail stores growing sales at these rates. As CEO Josh Silverman said on the second-quarter conference call, "Etsy is growing faster than most of them and already from a very substantial position of scale."
2. Buyers are flocking to Etsy
One reason Etsy is performing so well is explained by one simple thing that larger competitors in e-commerce are missing. Some Etsy sellers will send a handwritten note along with the item. This isn't uncommon when you buy from a small store owner, and this experience is consistent with the company's mission to keep commerce human.
The personal touch and ability to shop boutique stores across major retail categories is helping Etsy build a strong brand that distinguishes it from the garage sale feel of eBay (EBAY -0.62%). Etsy has invested in machine learning to make its website easy to browse, and the company's growth in active buyers shows it's working.
Active buyers stood at 60 million at the end of Q2, up 41% over the year-ago quarter. The telling metric is repeat buyers, which grew faster at 51%, reaching 26 million.
An expanding buyer base is attracting more sellers, and Etsy is investing in the growth of its seller base to help them grow their business. For example, the company is offering buyers such services as advertising and free shipping. Revenue from services makes up roughly a quarter of the business and has been increasing proportionally with gross merchandise sales.
The most important reason the stock is still a buy is that Etsy is very profitable, and the shares trade at an attractive valuation relative to growth.
Free cash flow totaled $366 million over the last four quarters. That is a high free cash flow margin of 32.5% relative to revenue. Although this growth stock has soared 169% year to date, it only trades at 41 times free cash flow, which looks attractive even relative to Etsy's pre-COVID-19 growth level.