Expect Etsy Stock to Double On Gushing Free Cash Flow and Stock Buybacks

Etsy (NASDAQ:ETSY) just produced excellent results for Q2 on Aug. 4, showing that the company is gushing forth huge amounts of free cash flow (FCF). Moreover, Etsy is now buying back large amounts of shares given the huge FCF it’s producing. The net result is to expect ETSY stock to skyrocket as long as this large amount of FCF continues gushing out of the company. My target price is 100% higher than its price as of Aug. 20 — $197.90, or $395.80 per share.

This may seem a bit antithetical to investors, as sell-side analysts are not predicting only incremental gains. That seems ridiculous to me given that not only is its FCF margin bound to rise, but the share buybacks will also help push up the price.

Let’s look at this more closely.

Where Things Stand For Etsy

Here are the guts of what I am talking about. In the six months ending June 30, the company produced $270.16 million in cash flow from operations (CFFO). That can be seen on page 10 of the Q2 press release. That was significantly higher than the $29.66 million in CFFO achieved in Q1, as can be seen on page 9 of the Q1 2021 release.

To determine the free cash flow (FCF) for the 6 months ending June we deduct the “Purchases of property and equipment” as well as the “Development of internal-use software” expense lines. This amounted to $9 million in the 6 months period and $1.828 million in Q1. Therefore the Q1 FCF was $27.83 million and for Q1 and Q2 it was $261.16 million. This implies that the Q2 FCF was $233.77 million, or 8.4 times the Q1 FCF.

The fact is that people are using ETSY much more than previously thought. For example, gross merchandise sales (GMS) was up 13% YOY and its revenue was up 14.2%. Moreover, what ETSY calls “habitual buyers” increased by 115% YOY, its fastest-growing buying segment.

All of this translates into higher FCF margins. For example, comparing its $233.77 million in Q2 FCF to the $528.9 million in Q2 sales results in a Q2 FCF margin that is amazingly high at 44.2%. We can use this to predict the company’s value going forward.

What ETSY Stock Is Worth

Analysts predict that sales for 2021 will reach $2.28 billion, and climb over 20.6% to $2.75 billion in 2022. So if Etsy can maintain this 44% FCF margin over that period, FCF will grow to $1 billion (i.e., 0.44 x $2.28 billion = $1.003 billion).

I can tell you that if the market realizes that ETSY will gush forth $1 billion in FCF by 2022, the stock will not stay at its present market value of $24.88 billion. That implies that its FCF yield will be 4% (i.e., $1 billion/$24.88 billion). This is the same thing (using an inverse math operation) as saying the price-to-FCF (P/FCF) multiple is 25 times (i.e., $24.88 billion / $1 billion).

The truth is that a more appropriate number would be at least 50 times P/FCF, which is also the same as a 2% FCF yield. So if we multiply the $1 billion estimate by 50 times the target value is $50 billion. That represents a potential upside of 100% over today’s price. This means that ETSY stock is worth 2x times its present price of $197.90, or $395.80.

What To Do With ETSY Stock

Even if it takes 2 years from now for ETSY stock to double to $395.80, the expected return is 41.42% per year on a compound basis. What that means is this. One year from now you can expect to see ETSY stock rise to at least $297.87, or roughly $300 per share. By the end of the second year (or probably earlier) you can expect it will hit $395.80, or roughly $400.00

This assumes that the company keeps up its very high FCF margin of 44%. I actually think the margin could move even higher. In that case, expect to see ETSY move up even faster.

Buybacks

Another factor that will help push up the stock is the company’s share buybacks. For example, in the 6 months ended June 30, it repurchased $180 million. In Q1 it did just $24.99 million.

In other words, $155 million of stock was bought back in Q2. That works out to an annualized rate of $620 million. This represents a buyback yield of 2.49% (i.e., $660 million/$24.884 billion in market value). That, in effect, is a major factor that will also helped push up ETSY stock.

On the date of publication, Mark R. Hake did not hold any position in any of the securities mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.