Etsy: Falling retail sales are great for long-term growth potential

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Clarkand Company

Online and offline retail businesses have taken a hit in recent months as Retail in the United States expenses have fallen. E-commerce stocks, like Etsy (NASDAQ:ETSY), fell faster in early 2022 as the sharp rise in interest rates lowered the present value of its expected future cash flows. Growth-oriented stocks with a higher “P/E” valuation are generally much more exposed to changes in interest rates due to the “DCF effectOf course, high-value growth stocks like ETSY have also been weakened this year as many speculative retail investors have looked to take profits after the bubble created in 2020.

Etsy faces a “double whammy” as it’s a retail-focused growth stock; its expected future cash flows and the present value of these cash flows decreases simultaneously. Both of these trends are clearly illustrated by the relationship between ETSY’s value, real retail sales growth, and the “real” (or after inflation) 10-year Treasury rate. See below:

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Data by Y-Charts

The stock soared in 2020 as real interest rates fell on the Fed’s QE program and rate cuts and were further boosted by a considerable increase in real retail sales growth. In the middle of last year, real retail sales peaked while the real interest rate bottomed, signaling the top of ETSY’s price bubble. Since the start of 2022, actual retail sales have reversed while interest rates have risen, negatively impacting ETSY’s fair valuation and expected earnings.

In my view, real interest rates are likely now near the top of their cyclical range and are likely to remain stable or decline (if the Federal Reserve pivots even slightly). Given this, I don’t expect most growth-oriented stocks to underperform other stocks simply because of valuation changes, as we saw earlier this year. ETSY is trading at a forward “P/E” of 27X today, which still looks high, but well below the 60X+ level from earlier this year. That said, weak consumer prospects and surveys reveal particularly large negative purchase frequency trends for Etsy, implying that it could see sales decline over the coming year. ETSY also attracted more short sellers with a higher level of short interest 9.8%. As a result, both bullish and bearish factors face the stock which I believe will cause it to experience significant volatility over the coming months, with holiday selling being a major potential catalyst.

Etsy and the Short-Term Economic Outlook

Etsy is undoubtedly a long term growth company, so it’s understandable that many investors don’t consider the short-term earnings risks to the company. Etsy’s market cap is less than 1.5% of Amazon’s. Although Amazon has a much larger total addressable market (especially given its non-retail business), Etsy has significant long-term growth potential. The company plans its $100 billion total addressable market, although its annual sales are only $2.5 billion so far. Still, if it made $100 billion in sales with a 5-10% margin (or $5-10 billion in revenue), it would probably be worth it at least 50 to 100 billion dollars or 250 to 600% more than today.

This projection is a “best case scenario” for Etsy, given that it can become its TAM keeping the competition at bay and, more importantly, its financial survival until then. I believe Etsy is likely to face the biggest economic test since its inception over the next two years due to changing conditions. Real retail sales are slowing, but I suspect they will fall much more dramatically in 2023 as falling real incomes lower consumer sentiment and savings. See below:

Chart
Data by Y-Charts

The main economic consumer demand data is historically abysmal today. Many people continue to spend but have much less ability to do so and start to pull back due to underlying inflation. While many analysts continue to paint a pretty picture for holiday saleseconomic data and trends of many distribution companies, as Target, clearly illustrate a difficult environment. In the short term, I believe Etsy will report a few quarters of sales and earnings well below current expectations. Items sold on Etsy are typical of the “better quality, higher cost” variety (compared to Amazon, Walmart, etc.) because artisans make a lot of them. As such, Etsy could see a bigger hit due to the “luxury pricing impact” as some people seek out cheaper alternatives.

Of course, the increasingly negative economic trend isn’t necessarily bad for Etsy from a long-term perspective. On the one hand, I believe that the dynamics of the recession could bring some older department store retailers (1,2,3) in liquidation or downsizing, which increases the competitive advantage of e-commerce. Second, economic downturns force companies to “clean house” and improve their operational efficiency, to the benefit of their long-term potential. Overall, while a significant drop in retail spending could temporarily hurt Etsy’s value, I think it could prove bullish in the long run as it would likely change the competitive landscape of Etsy for the better. retail industry. On that note, rising unemployment and layoffs may Also indirectly benefits Etsy by encouraging more people to seek out and create items and sell them on the platform.

Why Etsy May Grow Faster Than Expected

The stream consensus estimates for Etsy project EPS of approximately $4.1 for 2022 and 2023, followed by an increase to $6.5 by 2026. Sales growth estimates assume the company will increase revenue by 2, $5 billion this year to $4.1 billion by 2026 and $7.8 billion by 2031, achieving a YoY growth rate of around 10-17%. If these projections turn out to be accurate, ETSY would look a little overvalued today, having only a long-term “P/E” of 17.6X using 2026 EPS estimates. ETSY is a long and worthwhile opportunity, the company will need to achieve a more dramatic rate of growth over the next few years. Indeed, the company has achieved much faster sales and EPS growth over the past three years than expected; however, that may assume that the one-time boost of 2020 change doesn’t linger.

Given my economic outlook, I think Etsy could see EPS decline in 2023 as sales slow and people cut back on discretionary spending on more expensive items. However, 2023 could look like 2020 as negative headwinds for department store retailers drive a favorable market share shift to Etsy. Plus, Etsy’s value “pro-human“The business model can be huge as more shoppers turn to smaller businesses where one can find unique, handmade and higher quality items.

High inflation and supply chain issues are somewhat favorable to Etsy from a competitive standpoint. Many of its sellers are domestic and not heavily dependent on global supply chains (subject to fuel costs, geopolitical disputes, etc.). If, for example, the trade relationship between the United States and China collapses further, Amazon sellers would likely be much more exposed than Etsy, because more Amazon items are produced in China.

Also, as the prices of manufacturers’ inputs increase (raw materials), the price of all consumer items will increase. Low-margin “cheaper” sellers would have to increase their prices faster than higher-margin “quality” sellers to maintain the same net profit. For example, a rise in textile prices is less of a problem for a producer of high-end handmade garments than for a low-end “factory” manufacturer, because the high-end producer is likely to spend less on material inputs and more labor intensive than the low end. a. The price gap between factory-made and handmade items would decrease as material input costs increase. This point is subtle but could prove very favorable to Etsy in the long run.

The essential

Leader long term The risk I see is that Etsy officials fail to maintain the value of its “handmade” brand by allowing more mass-produced items on its platform. It’s a long-standing concern concerning the company. While allowing more “Amazon-like” sellers on the platform might temporarily boost profits, I believe it would undermine the company’s core appealing qualities – a platform for small artisans looking to sell unique items.

Ultimately, Etsy is an online platform with few physical assets, so consumer waste or seller trust could render it worthless and easily expose it to competitive alternatives. Etsy is a public company and, in my opinion, publicly traded companies have a bad habit of looking for short-term profits rather than long-term value. At this point, I don’t think Etsy is likely to go that route, but I’ll be mindful of popular buyer and seller sentiment for the business in case it develops negatively.

In my view, these qualitative and quantitative factors could fuel Etsy’s long-term growth. Increasingly likely economic headwinds could hurt its earnings in 2023, but could improve its potential as its competitive edge grows. For now, I’m officially neutral on the stock, as I suspect it could turn down temporarily as holiday sales and the outlook for 2023 disappoint amid headwinds. That said, even at its current price, it looks like ETSY will appreciate in value over the long term, as its potential market is far larger than its existing sales and is underpinned by many positive qualitative long-term growth factors.

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