Shares of handcrafted-goods marketplace Etsy (ETSY 2.86%) are down 55% from their all-time high. But they're also up 78% from their 52-week low, reminding investors how important perspective is when it comes to how you're gauging a stock's performance in the market.
Etsy's foundation looks solid enough for a compelling long-term investment, but it is facing roadblocks to its growth right now. That latter issue could limit returns in the near term.
Etsy's long-term foundation
Like other online marketplaces, Etsy experienced sensational growth because of the COVID-19 pandemic. But unlike its e-commerce peers, Etsy retained its growth, and that's worth a closer look.
First, the growth. Revenue for Etsy was up 111% year over year in 2020. In 2021, revenue grew another 35%.
Now, the retention. Through the first three quarters of 2022, Etsy's revenue is up only 9% from the comparable period of 2021, so clearly, growth has slowed. But the platform has retained nearly all of its users. At the end of 2021, there were 96.3 million active buyers. As of the third quarter of 2022, there were still 94.1 million.
Active buyers have dipped slightly, but 94.1 million is still more than double the 46.4 million active buyers it had before the pandemic started.
On Dec. 6, at the UBS Global TMT Conference, Etsy CEO Josh Silverman said something about this dynamic that I believe is completely overlooked and underappreciated by the market. Silverman repeatedly said that Etsy is a demand-constrained business, not a supply-constrained business.
In other words, there are currently more products available for sale on Etsy than it could ever hope to sell with its current level of demand. The platform can handle just about any surge that could come its way. This was proven in 2020. Revenue doubled without a hiccup. Merchants on the platform were ready to step up and supply the merchandise -- they were simply awaiting buyers.
Why are buyers still staying at Etsy this far removed from the start of the pandemic? Silverman says that buyers shopping with Etsy ended up surprised by the merchandise and selection they found on the platform. In other words, the platform exceeded shoppers' expectations.
The evidence points to Etsy's ability to hang onto the new user base it built up during the pandemic while being being ready for a new spike in demand whenever it comes.
Investors should keep in mind this is an attractive business model. By taking a cut from transactions on the platform, Etsy has a high gross margin of almost 71% as of the third quarter last year. And since the model has low capital requirements, operating cash flow in the quarter was nearly $207 million, quite good for a company with a market capitalization of only $17 billion.
Etsy's nearer-term focus
I bring up operating cash flow for Etsy, because net income looks abysmal at the moment. And that's because of the company's recent acquisitions of used clothes marketplace Depop and Brazilian handmade platform Elo7. Etsy acquired Depop and Elo7 in 2021 for $1.6 billion and $217 million, respectively. And to put it succinctly, it overpaid.
In the third quarter, Etsy took a $1 billion goodwill impairment charge to reflect the reduced value of these acquired businesses. This noncash charge shows up in net income and explains why the company has a net loss of $804 million year to date.
Fortunately, that charge is now behind Etsy, and it can turn its attention to growth for its smaller platforms. Management is taking what it's learned from operating Etsy, including its search algorithms, and applying it to Depop and Elo7 in hopes of growing these marketplaces.
That said, growth in 2023 will be hard to come by for the company. Gross merchandise volume (the total value of all sales) on the Etsy platform is about 6.5 times larger than the combined merchandise volume of its Depop, Elo7, and Reverb platforms. So even if Etsy manages to jump-start growth for these other marketplaces, the benefit to the overall business would be small.
As noted, Etsy's growth has slowed in 2022. Management noted that trends improved in October. However, it still guided for revenue of only $700 million to $800 million for the fourth quarter. For perspective, this means revenue could actually be down from the $717 million reported in the fourth quarter of 2021.
With growth challenged heading into 2023, Etsy may be a stock the market remains bearish on in the near term. However, its business has notable strengths and the ability to meet demand whenever it reaccelerates. Therefore, Etsy stock looks like a stock that long-term investors can patiently build a position in for the foreseeable future.
