Is Etsy Stock a Buy?

Etsy's (ETSY 2.86%) stock price tumbled after the e-commerce company posted its second-quarter earnings on Wednesday, Aug. 4. It beat Wall Street's top- and bottom-line estimates, but its guidance came up short.

Etsy's revenue rose 23% year over year to $528.9 million, beating estimates by $3.2 million. Its net income grew 2% to $98.3 million, or $0.68 per share, and cleared expectations by four cents.

But for the third quarter, Etsy expects its revenue to rise just 11%-16% year over year, compared to the consensus forecast for 17% growth. That softer-than-expected guidance sank the stock -- but did investors overreact and open up a buying opportunity for long-term investors?

Image source: Getty Images.

Was Etsy's slowdown that surprising?

Etsy's growth accelerated significantly in 2020, for three reasons: The COVID-19 pandemic drove more people to shop online, it sparked brisk sales of handmade face masks, and it drove more musicians to Reverb, the online musical instrument marketplace it acquired two years ago.

Source: Etsy. GMS = gross merchandise sales. YOY = Year over year.

Therefore, Etsy was destined to face tough year-over-year comparisons in sellers, buyers, gross merchandise sales (GMS), and revenue as more businesses reopened, COVID-19 restrictions were lifted, and people bought fewer face masks.

To brace for that slowdown, Etsy agreed to buy the U.K.-based fashion resale marketplace Depop and the Brazilian artisan marketplace Elo7 in June. Etsy expects to close both deals in the third quarter of 2021. Those two acquisitions should boost Etsy's international GMS, which already accounted for 41% of its total GMS in the second quarter. That's up from 32% in the prior-year quarter.

What's next for Etsy?

Etsy management expects the company's GMS to rise about 12.5% year over year in the third quarter, but noted Etsy's stand-alone business would only generate "mid-single digit" GMS growth. But excluding face mask sales from both periods, it expects Etsy's stand-alone GMS to grow by the "mid-teens."

That forecast indicates face masks boosted Etsy's GMS throughout the pandemic, but that temporary spike is forcing it to repeatedly provide "non-mask" metrics to reflect the growth of its core business.

Excluding masks, Etsy's stand-alone GMS in the second quarter rose 31%, which was much better than the 14.2% stand-alone growth it actually reported. That big gap was caused by declining sales of face masks, which only accounted for 1.4% of Etsy's stand-alone GMS during the second quarter.

Etsy will face messy year-over-year comparisons over the next few quarters. But like Amazon (AMZN 1.30%), which recently told investors to focus on its two-year CAGR instead of its volatile near-term growth, Etsy's CFO Rachel Glaser told investors during the conference call that Etsy's "non-mask GMS growth on a two-year basis remained fairly stable relative to last quarter and the historical trend line."

Glaser pointed out that on a two-year basis, Etsy's stand-alone marketplace generated triple-digit percentage growth in April, May, and June -- but admitted "there has been steady deceleration as the world has reopened."

Focusing on acquisitions, ads, and overseas growth

Analysts expect Etsy's revenue to rise 33% this year, then grow 20% next year as its business normalizes in a post-pandemic market. They expect its earnings to rise 16% this year and grow 22% next year.

We should take those forecasts with a grain of salt since the pandemic isn't over and Etsy could still make more margin-squeezing acquisitions. Etsy's recent investments and acquisitions already reduced its adjusted EBITDA margin year over year from 35% to 26% in the second quarter -- and it expects that figure to dip to "about 25%" in the third quarter.

Etsy could also acquire other platforms with lower take rates (the percentage of each sale it retains as revenue) than its core marketplace to expand overseas. It already expects Depop and Elo7 to slightly reduce its consolidated take rate in the third quarter, and buying out other marketplaces with lower take rates could squeeze its long-term margins.

However, Etsy can still expand its Etsy Ads business -- which lets sellers post ads on Etsy and Alphabet's Google Shopping -- to offset that pressure with higher-margin ad revenue. Etsy's consolidated advertising revenue, which includes Etsy Ads and Reverb's Bump, grew 44% year over year during the second quarter, but still decelerated from its 93% growth in the first quarter of 2021.

Should you buy Etsy's stock?

Etsy's long-term prospects still look bright, but its stock was due for a breather after its price rallied more than 50% over the past 12 months. Etsy was already trading at more than 50 times forward earnings prior to its earnings report, so it isn't surprising that its softer-than-expected guidance dented the stock.

Etsy's stock could remain volatile as it faces tough year-over-year comparisons, but I believe the stock is still worth buying. It enjoys a first-mover's advantage in the online artisan market, it has plenty of staying power against Amazon, and it's expanding its e-commerce ecosystem with smart acquisitions.