Did the market get it wrong again on Etsy, as stocks gain after earnings?

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ETSY (NASDAQ: ETSY) is an American e-commerce company specializing in handmade, vintage, and craft-related items. They sell a wide range of products including jewelry, bags, clothing, home decor, and art. Etsy shares rose 10% during market hours and another 1.7% during trading hours as results came in better than expected. Other e-commerce companies such as Shopify (NYSE:SHOP) also posted gains as results were better than expected, with negative sentiment already priced into the valuation. Etsy shares are down more than 65% from their 52-week high.

Strong points

-Gross merchandise sales decreased 0.4% year-on-year.

-Revenues increased 10.6% from the same period last year to $585 million.

-Net income decreased by 25%, while adjusted EBITDA (non-GAAP) increased by 16.7%.

“Second-quarter sales increased more than 10%, despite strong macroeconomic headwinds and difficult year-over-year comparisons,” said Rachel Glaser, chief financial officer of Etsy, Inc. “This growth is attributable to increased transaction fees in the Etsy Marketplace, the addition of Depop and Elo7 to our House of Brands portfolio, and the strength of our Etsy Ads product, which continues to grow. be a great solution for sellers looking to grow their business. We are delighted that Etsy’s highly variable cost structure helped generate a strong second quarter Adjusted EBITDA margin of 28% and operating cash flow of $125.8 million.

Etsy’s gross merchandise sales continued to struggle as the 2021 base effect and economic weakness continued to weigh on results. The company continues to improve its business model as it seeks to become relevant again. For years, management had indicated that the potential addressable market for their company was over $100 billion and that growth would continue to be strong for many years to come, but the results fell short of expectations.

Etsy has been focused on improving its overall product experience as it seeks to improve customer retention and repeat sales. Some of these improvements have started to pay off, as the current quarter has seen a 30% drop in dead-end searches as search has been improved with many advancements. The company also continued to improve its ad ranking capabilities, which translated into Etsy’s profitability. A new buyer protection program has also been introduced and is expected to go live after 1st of August, which will help sellers and customers who sell or buy items for less than $250 to receive a refund in the event that the order does not meet expectations.

The company has struggled to expand beyond the North American market, but management has been working to improve its go-to-market strategy for the international market as it seeks to get back on the path to the growth.

The main reason for Etsy’s slowdown can be attributed to their overall strategy, where they tried to offset a slowdown in growth, by raising their fees from 5% to 6.5%, and more than double the 3% that Etsy used to charge a few years ago. As a result, many sellers have been disabled and moved away from the platform, resulting in slower growth for traders. Etsy did not report merchant growth for the quarter, but the numbers were likely lackluster. In addition, the number of active buyers fell slightly by 2% to 88 million. Repeat buyers are categorized as those who spend more than $200 in a 12 month period.

Etsy’s management, in order to compensate for the difficulty in selling merchandise, increasingly turned to advertising sales to generate revenue. This strategy remains cautious, despite the fact that advertising budgets increased by 80% in the quarter, with ads being strongly dependent on demographics. The company also continues to focus on product development, with the product and development budget dropping from 10% of revenue to 12%. But given Etsy’s purchasing power and customer demographics, a high-end product may not suit market sensitivities.

Etsy Rating

Etsy continues to have a relatively aggressive price-to-sales ratio valuation of 6x and a price-to-earnings (P/E) ratio of 36. Investors continue to invest in the company as they are confident that the company will able to straighten out his business eventually. One of the reasons for the high valuation is the gross margin which is currently 71%, and the profit margin excluding adjustments hovers around 12-14%. Investors believe the sluggish nature of the company could ensure that profit margins could rise by 20-30% in the long term, which could lead to a spike in earnings, thus justifying current valuations. Additionally, metrics such as return on investment and return on equity also remain strong at 16% and 71% respectively, which helps as long as the business is growing.

Etsy’s shares soared as results weren’t as negative as the market expected. But the current business model is clearly struggling and the company may need to cut costs in order to return to growth in its core business.

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