During the early days of the pandemic, Etsy's (ETSY -2.17%) growth soared. The platform brings together buyers and sellers of handmade items, and shoppers have flocked to it for everything from jewelry to face masks.
But, like other retailers and e-commerce companies, Etsy has been unable to escape the headwinds of high inflation, rising interest rates, and other economic woes. In the fourth quarter, its gross merchandise sales and net income fell. Shares of Etsy also have been on the decline over the past year. So is it time to sell this e-commerce stock? Not necessarily. One thing in particular could make Etsy a long-term winner.
Etsy's business model
It all has to do with Etsy's business model. The company doesn't operate warehouses where it stocks products to ship out to shoppers. Instead, it offers an online selling platform to small business owners -- and these small businesses take care of the storage and transport of their items to customers. Etsy generates revenue through its services to these businesses. For example, it charges a 6.5% fee on transactions made via its marketplace.
All of this makes it a capital-light business, which has helped it turn earnings into free cash flow. In fact, since 2017, Etsy has transformed almost 100% of its EBITDA (earnings before interest, taxes, depreciation, and amortization) into free cash flow.
The chart below shows how consolidated free cash flow has grown from the pre-pandemic year of 2019 through today. It declined somewhat in 2021 after an enormous gain in 2020. But in 2022, free cash flow was on the rise again -- and it remains well above the pre-pandemic level.
Image source: Etsy.
Its capital-light strategy has helped the company maintain a strong cash position; it finishes 2022 with a cash balance of $1.2 billion.
In times of economic turbulence, that business model can cushion it from the impact of some of the headwinds. It isn't immune to inflation -- but it doesn't have to worry about the rising costs of operating factories or transporting goods. As for its sellers, yes, they feel the pressure of inflation too. But as small businesses, they have more flexibility than big players. Many operate out of their homes or small shops. So, like their partner, Etsy, they aren't facing enormous increases in storage expenses or delivery challenges.
And when the economy improves, Etsy's business model can help the company move more quickly into a high-growth phase.
Putting the slowdown into context
It's also important to put the company's recent slowdown into context. And to do that, we should compare the Etsy of today to the Etsy of 2019. The company is three times as big as it was then. Annual gross merchandise sales on its marketplace have increased to more than $11 billion from $4.7 billion in 2019. And the company has doubled its number of active buyers since that time.
Etsy also has made progress in the key growth market of Germany. Its gross merchandise sales there are now four times what they were in 2019.
So, yes, Etsy's navigating tougher times these days -- like many other retailers. But it's managed to keep the gains it has made since before the pandemic. This shows us the company wasn't just a pandemic stock. Instead, Etsy is a business that can keep on gaining over time.
Today, Etsy shares are trading for 30 times forward earnings estimates. That's down from more than 60 a little more than a year ago. This looks like a bargain considering its business model and performance over the past three years.
During the company's recent earnings call, Chief Financial Officer Rachel Glaser referred to the saying, "you can't stop the waves, but you can learn how to surf." Glaser said that in today's environment, Etsy has shown it can surf. That makes this growth stock a solid pick for investors -- in calm or rough waters.
