It's been an unpleasant time to be an Etsy (ETSY 0.83%) shareholder, to put it mildly. Lapping the financial results from year-one of the pandemic was never going to be easy -- Etsy was more than doubling in size in 2020 through early 2021 -- but I didn't expect a round-trip that would erase nearly all of the stock's gains since the first half of 2020.
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There are good and valid reasons for this fierce crash. Growth in the first quarter of 2022 was anemic compared to a year ago, a number of Etsy sellers are voicing displeasure with another take-rate increase on sales, and Etsy may have overpaid for its acquisitions of Depop and Elo7 last summer, when e-commerce and technology company valuations were at peak euphoria. In spite of these issues, I remain undeterred -- and am considering adding a little to my position in Etsy. Here's why.
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1. Acquiring lots of new buyers
Active buyers across all of Etsy's businesses totaled 95.1 million in Q1, up from 90.7 million last year. However, excluding music equipment sales site Reverb and more recent acquisitions Depop and Elo7, total Etsy.com buyers were 89.1 million -- down slightly from 90 million a year ago.
Gradual reopening of the economy and return to in-person shopping is to blame here, but I believe there's some silver lining. The company said it added 7 million brand-new Etsy buyers in the quarter. There are another 100 million shoppers who haven't made a purchase in over a year, and 180 million estimated unique visitors to Etsy.com every month. That represents a lot of potential being left on the table, and it's one of the reasons the company is justifying its take-rate increase to 6.5% from 5%, which went into effect in April.
Put another way, e-commerce is huge, and Etsy still commands just a tiny fraction of the pie. It plans to boost spending on various initiatives to convert more of those virtual window-shoppers to actual purchasers. Management believes it can attract a lot more buyers for its 5.5 million sellers on the Etsy site, excluding another 2.2 million sellers on Reverb, Depop, and Elo7, with the extra revenue flow from its take-rate increase.
2. Growth is about to pick up again
Total gross merchandise sold (GMS) across all of Ety's businesses increased just 3.5% year over year in Q1 2022. However, again excluding Reverb, Depop, and Elo7, Etsy.com GMS actually declined 2% year over year. The company points out that its GMS is up a whopping 177% since the first quarter of 2019, so it's encouraging that Etsy is at least holding on to most of its gains since the start of the pandemic and subsequent unwind of online shopping habits. But still, the year-over-year decline is concerning.
However, now that the first-year results of the pandemic are in the rearview mirror, Etsy could be poised to rekindle its growth rate again. Q2 2022 GMS is expected to be up as much as 5% year over year to $3.2 billion, and revenue is expected to increase as much as 11.5% -- of course, again helped by the increase in percentage taken from sales. We can assume this outlook also accounts for a global economic slowdown -- the same one that's currently racking the stock market overall
Nevertheless, year ago financial comparables are about to get a lot easier, versus the triple-digit percentage rates of expansion the company was reporting from early 2020 through Q1 2021. Time will tell, but I believe Etsy can start to climb at a more robust annual pace from here.
3. An e-commerce site that's actually profitable
Adding the small Depop and Elo7 into the mix is causing some headwinds to the bottom line, and Etsy is also launching initiatives to make the buying and selling process better. Despite this, though, the company overall is still highly profitable. Free cash flow in Q1 was $50 million, and $529 million over the past year, a healthy free cash flow profit margin of 22%, which includes just an 8.6% free cash flow margin in Q1 2022 resulting from elevated expenses from incorporating acquisitions.
Finding a modern standalone e-commerce platform that's able to generate consistent profitability isn't easy. After the sell-off, Etsy stock trades for 26 times trailing-12-month free cash flow. It isn't cheap, but I think it's a reasonable valuation for the long term if the company can kickstart its growth engine once again.
