Is It Time To Take A Second Look At Etsy Stock?

  • Etsy recently reported healthy Q1 2016 results that exceeded Wall Street expectations.
  • Notably, Etsy swung to a profit for the first time since its IPO.
  • Does Etsy pass the test as a suitable long-term investment?.

Etsy (NSDQ:ETSY) stock shot up by as much as 17% in aftermarket trading after the company reported healthy Q1 2016 results that not only beat top and bottom line expectations but also posted a surprise profit. Etsy reported first quarter revenue of 81.85M, good for 39.8% Y/Y growth and $6.7M higher than Wall Street consensus. That was a considerable improvement compared to the fourth quarter when growth clocked in at 35%. Meanwhile, Etsy reported net income of $1.2M, good for EPS of $0.01 compared to net loss of $36.6M (EPS of -$0.84) that the company posted during last year's comparable quarter.

Most of Etsy's growth and profitability metrics showed a marked improvement. The company posted gross profit of $53.9M, 42.6% higher than a year ago while gross margins improved 130 basis points to 65.9%. Non-GAAP adjusted EBITDA surged 121.1% Y/Y to $14.8M while EBITDA margin expanded 660 basis points to 18%.

Meanwhile, Etsy's expense growth remained muted, an indication that the company's cost discipline is working. Total operating expenses grew just 10.5% Y/Y to $47.2M, much slower than top line growth. Consequently, operating expenses as a percentage of revenue dropped to 57.6% from 72.9% a year ago. The company's major line items all grew considerably slower than the top line:

  • Marketing expenses (33.6% of operating expenses) increased 29.8%.
  • Product Development expenses(25.9% of op. exp.) increased 22.2%.
  • General and Administrative expenses (40.5% of op. exp.) fell 6.8%.

Etsy has its Seller Services to thank for the top line beat. This is the money that sellers pay Etsy for services such as Promoted Listings in a bid to make their listings more visible and boost sales. Seller Services revenue climbed 59.6% Y/Y to $43.5M, an improvement compared to fourth quarter growth of 53.9%. Etsy now gets most of its revenue from Seller Services (55%) than actual marketplace sales(45%). Marketplace revenue growth clocked in at 18.5%, much slower than growth in the Seller Services category.

Active buyers increased 20.1% to 25.027M while active sellers grew 12.3% to 1.603M.

Etsy finished the quarter with 281.7M in cash and zero debt.

2016 and Three-Year Guidance

Etsy did not provide specific guidance for the second quarter but reiterated its 2016 and three-year guidance that it had provided during its fourth quarter earnings call. Etsy said that it expects GMS (Gross Merchandise Sales) to post CAGR of 13%-17% from 2016-2018 and revenue to post CAGR of 20%-25% over a similar period. The company said that it expects GMS in 2016 to grow at the mid-point of its three-year guidance with revenue growing at the higher-end of the three-year guidance.

Has Etsy finally turned the corner?

This is, of course, the million dollar question. By most measures Etsy's latest report was quite brilliant. The company's top line growth accelerated while expenses grew much slower than the top line and allowed the company to swing to a profit for the first time in its public life.

Despite these strong key points, there are some notable weaknesses in Etsy's business that investors ought to keep an eye on. For starters, the company's revenue segment exhibits an odd dichotomy with seller services bringing in the lion's share of revenue. For a mature company like eBay (NSDQ:EBAY), seller services contribute just 21.8% to the top line while most revenue comes from actual selling activity. Looking at the guidance that Etsy provided, you notice that the company's GMS (most e-commerce companies refer to this as GMV, or Gross Merchandise Volume) is expected to grow considerably slower than overall revenue growth which implies that the company expects Seller Services to continue growing much faster than transactional revenue.

Etsy stock skyrocketed mid-last year after receiving a hat-tip by Alphabet Inc-C (NSDQ:GOOG) which said that Etsy was seeing a boost in traffic due to Google's efforts in using indexing that helps buyers find what they want within third-party apps. So maybe Etsy sellers are seeing higher traffic and are thus happy to spend more on Etsy's premium services. But Etsy's GMS growth of 18.4% is way lower than the growth in the amount of money sellers are paying for promotional services on the site. This is something that is clearly not sustainable and could come back to haunt Etsy in the coming years.

But right now the market is mostly concerned with top line growth and profitability for Etsy rather than the quality of earnings, and Etsy is excelling on that front. In this regard, Etsy stock is likely to remain a pretty good speculative play over the next three years or so. In any case Etsy stock is still trading 44% below the IPO price of $16 so some healthy gains can be made here if the company continues being profitable. Long-term investors with a with a time horizon of five-years or more should, however, probably wait for another quarter or two to see if the company's odd revenue dichotomy will show signs of normalizing.

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  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
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  • I do not have any business relationship with the companies mentioned in this post.
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