After its stock price climbed 301% in 2020, it might be difficult to understand how Etsy (NASDAQ:ETSY) could still be a great stock to buy right now. After all, management is calling for revenue growth to decelerate to a range of 15% to 25% year over year in the second quarter, which is way down from the triple-digit percentage growth levels achieved last year.
Still, Etsy’s stock price surged nearly 20% over the last month after management announced it was acquiring fashion resale marketplace Depop and the Brazil-based marketplace Elo7.
It may not have been the acquisitions themselves that sent the stock surging. Instead, the recent deals might have been a wake-up call for investors that Etsy still has tremendous growth opportunities ahead. Here are two reasons why Etsy’s stock still looks cheap and why it is a compelling buy right now.
1. Etsy is going after a $364 billion online apparel market
In June, Etsy announced a deal to buy Depop, a fashion resale app popular with Gen Z shoppers, for $1.6 billion. Etsy just recently completed a deal to buy Brazil-based marketplace Elo7 for an undisclosed amount, which extends Etsy’s addressable market to one of the fastest-growing e-commerce regions in the world.
Over the last year, Etsy has seen robust growth across numerous retail categories, including apparel, jewelry, and personal care items. Apparel gross merchandise sales (GMS) were up 83% year over year in the first quarter. But Depop’s niche focus in the vintage, second-hand fashion market has allowed it to grow even faster, with GMS more than doubling in Q1.
While apparel is not Etsy’s largest category, it represents Etsy’s biggest long-term growth opportunity. Apparel is the top e-commerce market, worth an estimated $364 billion, and is expected to grow at a compound annual rate of 9% through 2025.
With Depop, Etsy is getting a fast-growing brand that has a solid presence on mobile. One estimate puts the expected growth of the second-hand market at 39% from 2019 through 2024, reaching $64 billion.
With three acquisitions announced in the last two years (the third was for music equipment marketplace Reverb back in 2019), these deals probably won’t be Etsy’s last. The stock is moving higher because investors are starting to view acquisitions as a growth catalyst for Etsy. Between 2017 and 2020, Depop’s GMS grew at an annualized rate of 80%. At that rate, Depop could grow into a sizable marketplace of its own over the next decade.
2. The stock could double in value
Analysts expect Etsy to post revenue growth of 32% in 2021, with earnings per share (EPS) expected to be up 14% year over year. One reason for the lower expected earnings growth is the increase in brand marketing expense expected in the near term. The pandemic made it easy for Etsy to win over new customers, but with customers returning to in-store shopping, Etsy will need to spend extra on advertising to keep growing in the near term.
Looking further out, analysts expect improvement in operating margin to accelerate growth on the bottom line. EPS growth is expected to accelerate to 21.6% in 2022 and 33.2% in 2023. While increases in brand marketing may pressure margins in the near term, Etsy is a capital-light business, which paves the way for improving profitability as the business expands and reaches more buyers over the long term.
Over the last year, Etsy generated $787 million in free cash flow. That puts the stock’s price-to-free cash flow ratio at 35. But the consensus analyst estimate has Etsy growing free cash flow on a per-share basis from $4.97 in 2021 to $8.25 by 2023.
If the stock is still trading at 35 times free cash flow in two years, the share price could fetch $288, 47% above the current price level. If investors decide Etsy’s growth is worth a higher multiple, they could be looking at a double.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.