Etsy (ETSY 3.76%) was a pandemic phenomenon, producing triple-digit growth for several consecutive quarters as shoppers found its exclusive, handmade masks and stayed on for other fun and unique products. But as shoppers eventually went back to physical stores and adjusted their spending to focus more on services, Etsy now struggles to maintain growth as sales have leveled off or declined.

Wall Street noticed the trend and Etsy stock is trading down 25% year to date. It also fell, in part, on a disappointing earnings report last week. Is this now a stock to avoid, or is there a buying opportunity here?  

There's still a niche marketplace for Etsy

Let's first distinguish what is meant by declining sales. Etsy revenue in Q1 actually increased 10.6% over last year. However, consolidated gross merchandise sales (GMS) decreased by 4.6%, and Etsy marketplace GMS decreased by 4.7%. The consolidated results include Etsy as well as Reverb, Depop, and Elo7, other marketplaces it has acquired. That means consolidated sales, or the total amount shoppers spent, decreased, while Etsy's portion of that total, or its net revenue, increased. The increase in revenue can mostly be attributed to an increase in fees.

Take rate, which is the average amount of a sale that Etsy takes in fees, increased both year over year and sequentially, but that also came from the fee hike.

Etsy take rate.

Image source: Etsy.

Management is guiding for GMS to be about flat year over year in the second quarter and revenue to increase about 5% at the midpoint.

There are glimmers of hope for a comeback

The first quarter was challenging, but it wasn't all bad. Active buyers increased 1% over last year to nearly 90 million, the first increase since the 2021 fourth quarter. Reactivated buyers increased by 21%. New buyers increased by 7 million, which was a deceleration in growth, but demonstrated robust interest.

Management is tuned into the company's challenges and it is taking broad actions to address them. It knows some customers still only stop by for specific items, and that others find it difficult to find exactly what they're looking for. Etsy's ambition is to become a first stop for any shopper's e-commerce journey. To that end, it's improving its search engine to provide various types of functions like text-based results, relational results, and semantics. It's also developing conversation-based searching using generative artificial intelligence to get a better sense of what a customer wants and produce more relevant results more quickly.

In light of the inflationary environment, Etsy launched a page enhancement detailing low prices and high quality, which has already resulted in higher conversion rates. Its recent focus on ads has also contributed to sales generation, in addition to several other initiatives.

Profits are still healthy at $75 million, even though that was a 13% year-over-year decrease. And it's in an excellent cash position, with $47 million generated in free cash flow in the first quarter and $1.1 billion in cash on the balance sheets. 

One interesting finding of its research is that Etsy has strong brand awareness, but category association is extremely low. While 91% of shoppers know the brand, only 11% think of it when looking for gifts, while only 3% think of it for home and living products and style products, even though these are some of its highest-selling categories.

Is now the time to buy Etsy stock?

Etsy is clearly struggling in this climate, but it's also clearly a healthy business. I wouldn't worry about Etsy right now, but I also wouldn't rush to buy its stock while it's struggling through these issues. At this price, it's still highly valued, trading at a price-to-earnings ratio of 36. That's a fairly premium valuation for a business with slowing sales and declining profits. I would wait and reconsider Etsy when market conditions are more favorable and the company is demonstrating more results from its efforts.