Summary
- Etsy shares have fallen more than 40% from their all-time high.
- The company is currently valued at ~23 times trailing free cash flow.
- Even using conservative assumptions, ETSY could at least double from here in the next five years and currently offers a great margin of safety.
- A few simple charts show why ETSY is unlikely to stay below its current $5 billion valuation for very long.
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Investment thesis
Etsy (NASDAQ:ETSY) shares could at least double from their current level in the next five years and present an opportune margin of safety following a massive drawdown of more than 40% from all-time-high.
My reasoning is simple:
- Revenue growth is likely to stay above 20% for the foreseeable future, simply by following GMS (Gross Merchandise Sales) growth. Etsy has a proven track record of growing its two-sided marketplace with consistency over the years, both on the buyers' and the sellers' side.
- Margins were maintained or improved over the years, showing scalability.
- Free cash flow has grown by a whopping 275% over the past two years.
- Yet, valuation is only 23 times trailing free cash flow as of this writing.
- Management is buying back shares and has a very long-term mindset.
- TAM (Total Addressable Market) is gigantic, and Etsy is barely touching the surface with an estimated 4% market share in "special" online retail.
Above all else, the consistent operating history of the company since Josh Silverman became CEO in 2017 indicates a high predictability to the story.
By assuming a continued revenue growth around ~20% and continued margin expansion from 22-23% today up to 30% in the next five years, the company could generate more than half a billion in free cash flow in FY25. Needless to say, Etsy would trade at much more than its current $5 billion market cap by then.
I like to invest in businesses that have a strong chance to at least double in the next five years. And I believe ETSY's current setup offers exactly that.
A review of the bear case
Etsy shares have dropped more than 40% from their all-time high, reached earlier in 2019. And even at this level, many investors will point to unattractive traits the company is currently presenting:
- Amazon (NASDAQ:AMZN) Handmade could eat Etsy's lunch.
Etsy is not in a commoditized business. The very nature of its marketplace and products is to empower users to buy or sell uniquely crafted and personalized items. Amazon could certainly grow into a somewhat similar platform over time and manage to gain sellers that are currently active on Etsy. But specialty retail is an extremely fragmented, far from being a winner-takes-all market. At this stage, Amazon Handmade is charging a 15% referral fee. That's three times Etsy's take rate of 5%. This illustrates that Etsy has wiggle room in its pricing and positioning.
