To Beat the Bears, Etsy Has to Leap Over This Hurdle - The Motley Fool

Summary

With restrictions placed on physical shopping, and consumers spending more time than ever at home, online marketplace Etsy (ETSY -2.34%) absolutely thrived throughout the pandemic. Year-over-year growth in excess of 100% for both revenue and gross merchandise sales (GMS) was a normal occurrence in the quarters that followed the start of the pandemic.

But as the business faces near-term headwinds, stemming from reopening economies and high inflation, Etsy will undoubtedly have a harder time encouraging its 89.1 million active buyers (excluding subsidiary marketplaces Reverb, Depop, and Elo7) to transact more frequently, which is management's ultimate objective.

With restrictions placed on physical shopping, and consumers spending more time than ever at home, online marketplace Etsy (ETSY -2.34%) absolutely thrived throughout the pandemic. Year-over-year growth in excess of 100% for both revenue and gross merchandise sales (GMS) was a normal occurrence in the quarters that followed the start of the pandemic.

But as the business faces near-term headwinds, stemming from reopening economies and high inflation, Etsy will undoubtedly have a harder time encouraging its 89.1 million active buyers (excluding subsidiary marketplaces Reverb, Depop, and Elo7) to transact more frequently, which is management's ultimate objective.

Let's take a closer look at this specialty e-commerce marketplace.

Trying to drive repeat purchases

In the first quarter of 2022, Etsy increased overall revenue and GMS 3.5% and 5.2%, respectively, compared to the prior-year period, a marked slowdown from gains posted throughout the depths of the pandemic. Tough comparisons, as well as macroeconomic factors, are certainly to blame. For a stock that has skyrocketed 500% over the past five years, even after being down 63% this year, Etsy bears have had a tough go at it. Until now.

The biggest argument against investing in Etsy, whose shares trade for a compelling valuation of just 22 times this year's consensus earnings per share estimate, is that the platform will have a harder time attracting new buyers, as well as re-engaging existing buyers, in a more normalized economic environment. Throw in record inflation, and consumers might shy away from the discretionary items Etsy is known for.

The Etsy marketplace's base of active buyers actually declined by 600,000 year over year in the first quarter of 2022. This is in stark contrast to Q1 of 2021 when active buyers on the platform jumped by 91% year over year. Even more noteworthy is that repeat buyers (those who had at least two purchases in the trailing-12-month period) fell by 500,000 from Q1 2021 to Q1 2022.

Etsy's biggest product category -- 33% of GMS in the third quarter of 2021 on a trailing-12-month basis (last available data) -- is homewares and home furnishings. While these items probably command higher ticket sizes than other popular merchandise like apparel and craft supplies, they don't lend themselves to repeat purchase behavior. Shoppers can easily hold off on buying furniture in tough economic times.

Although the bears have a valid argument today, Etsy's management team is optimistic about the company's future. It is investing in various initiatives to make Etsy "more inspirational, efficient, and reliable," in order to boost purchase intent on the site and grow share of consumers' wallets.

"We believe our frequency opportunity is still in its infancy," Josh Silverman, Etsy's CEO, said on the Q1 2022 earnings call in early May.

From a financial perspective, attracting buyers and encouraging them to transact more has major implications. It could result in significantly higher expenses. Etsy's marketing spend, for example, remained essentially flat year over year. But as mentioned earlier, active buyers on the Etsy marketplace actually fell. Therefore, the business might have to lay out a lot more cash than it has historically to grow the user base.

On the flip side, if the leadership team is able to push higher levels of account growth, as well as drive repeat purchases, it can be a financial boon for the company. Having an engaged buyer requires less marketing dollars because these customers are already fully aware of Etsy's value proposition, and they don't need to be reminded constantly that the online marketplace is there to provide unique and handcrafted items. This can lead to a boost in margins, profitability, and ultimately, a higher stock price over time.

Companies that were successful during the pandemic are facing a new reality. Etsy shareholders will want to keep tabs on how the company progresses in addressing this new reality.

To Beat the Bears, Etsy Has to Leap Over This Hurdle - The Motley Fool
Photo Credit: The Motley Fool

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