Etsy: After A Record-Shattering 2020, Don't Rush To Buy

Summary

• Etsy had its best year on record in 2020, growing revenue and GMS at north of 2x y/y.
• Shares have nearly quintupled over the past year, but are currently down some 15% from highs during the recent tech rout.
• Etsy is still guiding to about 130% year-over-year revenue growth in Q1.
• But as we head into the rest of 2021 and Etsy starts comping against COVID-boosted results, its growth star fades.
• There are a number of categories that drove Etsy's surge in 2020, such as masks and home goods, that may not see nearly the same strength in 2021.
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With the recent rout in technology stocks, investors should be keenly on the lookout for richly-valued momentum trades that are still susceptible to further correction. Some of the best performers in 2020 may be highly at risk in 2021, and Etsy (NASDAQ:ETSY) is certainly one of those names.

The arts-and-crafts e-commerce site, once treated very dismissively by investors as a sort of second-rate eBay (EBAY), has seen its fortunes dramatically shift amid the pandemic. Amid a surge in e-commerce sales in general, both buyers and sellers flocked to Etsy's platform in 2020 to trade items from masks to home decor. Compounded with Etsy's 2018 decision to increase its fees on sellers (from 3.5% to 5.0%, a move that brought Etsy closer to higher-fee e-commerce alternatives like Amazon (AMZN) but triggered heavy backlash from its seller community), Etsy's revenue surged to levels never seen before.

Etsy's stock responded in kind, nearly quintupling over the past year. The February/March correction in tech stocks, however, has Etsy down ~15% from highs. The question for investors now is: is Etsy's trajectory upward and is now a good time to buy the stock on the dip, or will the weakness continue?

Data by YCharts

I continue to remain neutral on Etsy. I see both the bullish and bearish sides of the argument on this stock, and frankly I see a bit more risk to the downside on this stock than to the upside. The truth is that while Etsy executed tremendously while other businesses (especially consumer-facing retail businesses) struggled amid COVID-19, much of this strength is now in the rearview mirror and it'll be hard for Etsy to stage a repeat performance.

On the bright and bullish side of the Etsy argument:

• The pandemic has brought a flock of new buyers and sellers to the Etsy platform, dramatically expanding the platform's reach and potential, and Etsy may be able to retain them and drive repeat purchases from them.
• Etsy is expanding its monetization potential through services like ad placements, payments, and other services - boosting Etsy's gross margin and its "take rate" as a percentage of its GMS.

On the other hand, however, I'd be cautious of the following items:

• Etsy's 2020 growth was driven by many one-time factors. Mask sales are an obvious one, and though the mask GMS has already begun to fade, it still represented 4% of Etsy's Q4 GMS. Another at-risk category is home goods: like Wayfair (W) and Restoration Hardware (RH), Etsy saw a massive bump in demand for home decor because many families took the pandemic as an opportunity to move. This sudden, nationwide flight to new homes is not something that will continually recur.
• Re-opening of the U.S. economy has unknown impacts on Etsy's traffic and revenue. Much of the smaller items on Etsy's platform are likely sold to "bored shoppers" who are browsing their phones while they have spare time. We think e-commerce as a category will slide in 2021 as retail stores and offices reopen and consumers have competing demands for their time.

The biggest risk of all to Etsy, in my view, is its already-rich valuation. At current share prices near $208, Etsy has a $26.24 billion market cap. After we net off the $1.69 billion of cash and $1.06 billion of debt on Etsy's most recent balance sheet, its enterprise value is $25.61 billion.

The early quarters of 2021 will be a bit misleading for Etsy. For Q1, the company has guided to 125-135% y/y revenue growth, as shown in the table below:

Figure 1. Etsy Q1 guidanceSource: Etsy Q4 earnings release

Starting in Q2 and especially in Q3/Q4, however, Etsy will start comping against pandemic-boosted results. The company isn't guiding to full-year revenue, but consensus is calling for $2.18 billion in revenue - representing a reversion to 26% y/y full-year growth. Against this outlook, Etsy trades at 11.7x EV/FY21 revenue. Assuming the same 32% adjusted EBITDA margin that Etsy was able to notch in 2020, the company's EBITDA multiple would be 36.7x EV/FY21 adjusted EBITDA.

Now, neither valuation multiple is too ridiculously high, and the recent correction has already shaved a bit off of that valuation (hence why I'm neutral on Etsy). Yet I do think that once Etsy starts comping against last year's pandemic-boosted results, with few growth levers left to it, sentiment on Etsy will continue to be weak.

In my view, Etsy remains a watch-and-wait stock. I'd be more keen on buying Etsy if it fell to the ~$170 range (9.5x current-year revenue), which just represents a return to where Etsy was trading last December. Until then, however, I'm more content on the sidelines.

Q4 download

Let's now cover Etsy's latest fourth-quarter results in greater detail. The Q4 earnings summary is shown below:

Figure 2. Etsy Q4 results

Source: Etsy Q4 earnings release

Etsy's revenue grew 129% y/y to $617.4 million, decimating Wall Street's expectations of $517.7 million (+91% y/y) by a massive margin. Etsy's GMS (gross merchandise sales, the equivalent of what many other e-commerce companies might call GMV) also grew 118% y/y to $3.61 billion. You may notice that revenue grew at a slightly faster pace than GMS: this represents an 80bps increase in Etsy's take rate to 17.1%, driven by the company's focus on adding services like ads and payments.

Another impressive metric: Etsy now announced that it's the fourth most-visited e-commerce site in the U.S. The company also cited that its ~120% y/y GMS growth outperformed the e-commerce industry benchmark by 2.5x:

Figure 3. Etsy vs. e-commerce competitorsSource: Etsy Q4 earnings deck

Here are a few helpful anecdotal comments from CEO Josh Silverman's prepared remarks on the Q4 earnings call that describe some of the customer trends that Etsy is seeing:

Etsy added twice as many new buyers in 2020 as they did in 2019. In fact, there were many weeks in 2020 where Etsy added more than 1 million new buyers per week and we reactivated 22 million lapsed buyers. These are buyers who hadn't shopped in Etsy in at least a year. And they've come back to Etsy in 2020 at a time when they really needed us most to find that Etsy is better in so many ways than the last version of Etsy that they might have visited possibly years ago.

I'm particularly excited about the growth of habitual buyers. Habitual buyers were yet again our fastest-growing segment in the fourth quarter. And habitual buyers grew 157% year-over-year. 2020 was also a year when we grew the pie for many of our sellers. In fact, many of our sellers had their best year ever in 2020. GMS per seller was up 22%, while we simultaneously grew active sellers by 64%. We, of course, work hard to support our sellers by driving more sales. We also work hard to support our sellers in many other ways."

Where I am most concerned, however, is that Etsy's largest and fastest-growing categories may not experience the same growth tailwinds in 2021.

For example, out of Etsy's total $10.3 billion GMS in 2020, roughly 30% ($3.2 billion) came from the housewares and home furnishings department. As I previously mentioned, the fact that many families embarked on short-term moves amid the pandemic drove this category much higher, something that may not recur. I'd also say that categories like craft supplies ($1.2 billion or ~12% of 2020 GMS) will also see a decline as people have less time to spend at home. And of course, masks ($743 million of 2020 GMS, or ~7%) will shrink as a category as mask restrictions are lifted worldwide.

Figure 4. Etsy GMS by categorySource: Etsy Q4 earnings deck

Key takeaways

There's no doubt that Etsy has achieved phenomenal growth in 2020, but the question is, as we move on to 2021 that faces re-opening as well as a tough prior-year com, does Etsy still have enough tailwinds at its back to keep investors dazzled? In my view, Etsy's ~12x forward revenue multiple already fairly values a company that faces rather uncertain and difficult-to-predict growth in 2021. Watch this stock, but don't rush to buy it immediately on this dip.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.