When it comes to customizable handmade goods, there's no better place to shop than Etsy (ETSY 2.15%). The specialty online marketplace benefited from the wave of e-commerce spending in 2020 and 2021, but has experienced the pain of demand evaporation in 2022.
That drop has affected Etsy's stock significantly -- it's down more than 60% from its all-time high. Sales volumes on its platform are also suffering as consumers dial back on discretionary spending in light of inflation -- people's dollars just don't stretch as far as they did last year.
However, I think the same issues that have been dragging on its business could create a boom for Etsy this holiday season.
Etsy should thrive this holiday season
How this holiday season will turn out for retailers is highly unpredictable. First, supply chain issues could still cause shortages of in-demand items. Second, it's unknown what sort of financial condition consumers will be in, or what their mood will be.
I think Etsy is uniquely positioned to navigate this challenging environment. The merchants who use it tend to supply handmade or custom goods that will be less affected by the supply chain issues plaguing more technological products. And if people feel the need to tighten their budgets, Etsy may look like an even more appealing option for finding unusual, but less expensive, gifts. The sort of customization that many Etsy vendors specialize in can make relatively low-cost gifts seem priceless.
We'll likely hear about how management plans to approach this opportunity when the company reports its Q3 results later in October or early November.
Investors will also be looking for Etsy to reverse its current business trends.
The latest results weren't impressive, but the future remains bright
In the second quarter, Etsy's primary metrics were a mixed bag.
| Metric | Q2 2002 | Year-Over-Year Change |
|---|---|---|
| Gross merchandise sales | $3.03 billion | (0.4%) |
| Revenue | $585 million | 10.6% |
| Operating expenses | $341 million | 17.3% |
| Net income | $73 Million | (25.6%) |
Source: Etsy.
Even though its gross merchandise sales figure was pretty even, Etsy did grow its revenue. However, the top line was boosted by the company raising its transaction fees from 5% to 6.5% in April, so this growth comes with an asterisk. It cannot repeat that maneuver regularly.
Additionally, its operating expenses rose faster than revenue, which caused its net income to fall drastically. Management will need to reverse this trend, especially if my holiday prediction is wrong and consumers display conservative shopping habits.
The third-quarter trends so far look similar. Gross merchandise sales are expected to be down a bit year over year, while revenue is expected to grow by about 5%. However, the real attention grabber in the Q3 report will be management's Q4 projections, as the holiday season is Etsy's peak season.
Regardless of what happens in the remainder of this year, analysts are projecting Etsy's 2023 revenue will grow by 10.8%, with earnings also increasing.
ETSY PS Ratio data by YCharts
Considering Etsy's low valuation from both a price-to-sales and free cash flow standpoint, now could be an excellent time to open a position in Etsy. Additionally, in its current state, with operating expenses rising, its free cash flow isn't optimized. As Etsy's expenses normalize with its slower revenue growth, investors can expect free cash flow to increase.
Additionally, Etsy is building its ad business, allowing it to generate a new revenue stream that could also increase merchandise sales on its platform, creating a flywheel effect. Over the past five years, its ad business has grown by 516% versus 253% growth in gross merchandise sales. That's impressive, and the growth looks to keep coming as Etsy's sellers have increased their ad budgets by 80% since 2022 began.
While Etsy's stock may have performed poorly in 2022, I think it can end the year on a high note and excel in 2023 as its ad business increases. As a result, Etsy is an excellent buy at this valuation, and investors shouldn't miss their chance to add this top-tier e-commerce stock to their portfolios.
