Buy Wayfair on growth potential, Avoid Etsy: Analyst
E-commerce platforms have room to run under Amazon's dominance in the space. Chinese online retail site Temu even advertised several commercials during this year's Super Bowl.
Citi Internet Analyst Ygal Arounian joins Josh Lipton for the newest installment of Yahoo Finance's Good Buy or Goodbye to share his take on relevant e-commerce stocks.
Arounian prefers home goods website Wayfair (W) as his Good Buy, pointing to its growth potential in the space and product diversity for consumers with different spending thresholds. Arounian cites Trump-era tariffs on China as a major challenge for the retailer.
Inversely, Arounian finds Etsy (ETSY) to be a Goodbye stock on its overexposure to consumer discretionary spending and broad macro headwinds that challenge the site's fundamentals.
Catch more episodes of Yahoo Finance's Good Buy or Goodbye here, or watch this full episode of Yahoo Finance Live here.
Editor's note: This article was written by Luke Carberry Mogan.
Video Transcript
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JOSH LIPTON: It's a big, noisy universe of stocks out there. Welcome to Good Buy or Goodbye. Our goal, to help cut through that noise to navigate the best moves for your portfolio. And today, we're going to be looking at two e-commerce stocks that are heavily influenced by consumer discretionary spending. As China looks to take market share and pandemic supply chains begin to normalize, what's the best way to play it now.
I'm here with Ygal Arounian, CitI Internet Analyst. So, Ygal, thank you for joining us, sir. Today, we're going to start off with your first buy here, Ygal. You get this chart moving. Let's see, here we go. All right, Wayfair, Ygal, I'm going to run through the reasons you say, Ygal, this one is a buy. For viewers who are playing along at home, let's go through the first reason, market dominance. Explain that one to us, Ygal.
YGAL AROUNIAN: Yeah, so that's an interesting one. This is a really fragmented market. So there is no real fully dominant player. But Wayfair is the leader for pure play online, for sure. And if-- in terms of dominance, what they have been doing right is taking share, right? And so, this is a market that's been really challenged over the past couple of years. We're still seeing pressure on the consumer and how they're spending. We're not seeing a rebound in the home goods category just yet. But Wayfair has been taking share over the past couple of quarters, so they have been outperforming their competitors. And that's one of the reasons that we like it right now.
JOSH LIPTON: All right, market dominance is your first reason. Let's get to the second one, margin expansion. You say, Ygal, this could actually be material looking ahead.
YGAL AROUNIAN: Yeah. So we're really early in the margin expansion story here. Wayfair invested a lot over the COVID period, as a lot of other companies did. And made sense, given the strong growth that they had in terms of sales when everybody was locked at home and buying furniture for the home office and the backyard, and everything. That-- all of that slowed.
And so, they've had to rightsize. They've been through a number of layoffs and cost rightsizing. And we're now at an inflection point where they've started to generate cash over the past couple of quarters. So they're free cash-flow positive, they are EBITDA positive, they've been coming in ahead of schedule over the last couple of quarters on this. So they've been executing well on the cost cuts. And we're still very early. The EBITDA margin right now is mid-single digits, low to mid single digits.
They-- in the most recent round of layoffs, which was unfortunate but was necessary, the management talked about getting to $600 million of EBITDA, potentially even in a flat revenue scenario in 2024. So if the market doesn't rebound, they're still talking about $600 million of EBITDA. That would represent about 5% EBITDA margin. They've talked about getting to 10%, that's their near-term target. No specific timeline on it, but near-term.
And then they had an investor day last year where they painted a longer-term picture where they can get to-- actually get to the high teens. So if they continue to execute, they'll need some support from the market, and consumers will need to come in. But if they continue to execute, we're still very early on this trajectory, and you could see material margin expansion over the next couple of years.
JOSH LIPTON: And the final one, Ygal, final bullet point here, growth potential, walk us through that.
YGAL AROUNIAN: Yeah. So, like we said, they are taking share from their competitors. So that's been really important. And this is a segment that is seeing movement online, right? So this category is still below average in terms of e-commerce penetration. So they're boosted by that. Their brand really resonates. They are kind of-- they have multiple brands, right?
Where they punch the most is in the middle tier, and they have a lot of products at value, but they also have above as well. So like on higher-tier products, and they have higher-tier brands, and they talk about B2B as a potential opportunity. So they're still really early, e-commerce shift benefits them, and then they've got areas where they're still under-penetrated.
JOSH LIPTON: Got it. And I'm guessing you like this name, so valuation, you must still think is attractive at these levels, too, right?
YGAL AROUNIAN: Yeah. We think the valuation is a little bit trickier just because they are early on the profitability front. But if they are making the progress that we expect to see here on the margins, the EBITDA valuation looks pretty attractive. So they're in the low teens, and they could really run from there.
JOSH LIPTON: So finally, viewers at home, they're convinced, Ygal. You got them, they're ready to commit capital. Before they do, what are some risks they need to know about?
YGAL AROUNIAN: Yeah. So Wayfair is a really interesting one because it's not the cleanest story right now, right? On the macro front, in particular, that's probably the biggest near-term challenge that we do enter into a recession, that hasn't happened yet, the consumer does get softer, and the category remains under pressure. That's probably the biggest near-term one.
Over the last week or two, we've heard about potential Trump tariffs on inbound China goods. That could have a potential impact. We haven't heard anything specifically on the Red Sea drama. That could potentially impact some of the cost of goods coming in from China as well. So that's a potential risk. Those are the main ones.
And then, the last one I just mentioned is they, again, they need to make progress here on the profitability front. They do have a good amount of debt coming due over the next couple of years, mostly in convertible notes. And they need to really get that on the free cash flow side and generate enough cash so they can address that debt.
JOSH LIPTON: All right, so Wayfair is the one you like, Ygal. Let's go to one you don't like. And this one's interesting. This is Etsy. Let's go through these reasons right here. The first reason you would say Etsy is one to avoid, low-volume growth.
YGAL AROUNIAN: Yeah. So for Etsy, at first, let's start off by just saying they have an incredible management team, and we might get to that on the risks to this call. And they've done a great job. And they were super successful during the early part of COVID. They saw a triple-digit top-line growth and volume growth. They saw their buyers double. And they've hung on to the majority of those gains.
So Etsy did a great job. The challenge is, over the last year or so, they've kind run out of steam. And they haven't been able to recapture that growth profile again. And it's a little hard to see in the near term, they are fully exposed to consumer discretionary. That's exactly where they live. In the near term, it's hard to see them move past that, if that happens.
JOSH LIPTON: And that was actually your second point, too exposed to discretionary spending for your likes.
YGAL AROUNIAN: Yeah. I mean, 100% of the volume on their platform is consumer discretionary, and we talked about that with Wayfair too, but there are some different dynamics. And so those headwinds are really challenged. Where we're seeing the biggest impact on spending right now is on consumer discretionary goods. Where you've seen a shift on spend from goods to services. That hasn't really gone away. We're seeing with prices rising on essentials and non-discretionary items. That's where consumers are focusing their spend, and where, unfortunately for Etsy, where that is getting hit the most is on consumer discretionary spend on goods.
JOSH LIPTON: And, Ygal, quickly here, competition, that's your third reason. How come?
YGAL AROUNIAN: So we got asked about the rise of Temu, in particular, and Shein, more than anything I think in e-commerce, from our clients. And Etsy actually called out the competition from Temu last quarter, it's having an impact on them. There's a couple of things going on. One is a dollar spent on Temu is a dollar less spent on Etsy. And their management team talked about seeing some of that impact. And then, the other factor is Temu was spending a ton of money on advertising. If you watch the Super Bowl,--
JOSH LIPTON: Sure did.
YGAL AROUNIAN: --you saw multiple TV ads. They're spending a lot on performance marketing. And Etsy drives traffic and sales through performance marketing. That's lifting the prices of performance marketing, which is making it harder to drive profitable ROI. And Etsy has had to shift some of their spend from performance into other channels. The challenge is the ROI, the payback period on that is a little bit longer, so it takes longer to capture the value from a TV budget than a Google budget.
JOSH LIPTON: Got it. Let's end here. How could you be wrong, Ygal?
YGAL AROUNIAN: Where we could be wrong is, I'd go back to this management team, who is excellent. Josh and Rachel started both in 2018 around the same time, they completely turned around this company. So they are being run by a really trustworthy set of hands. And I think there's a lot of value in that. So you can kind of trust them to try to rightsize the ship. Again, in the near term, I think the headwinds are a little bit too big. We could see the consumer rebound a little bit faster than expected, and that would help boost some of the strategy. And if they do a good job addressing the new competitive landscape, that could be another thing that brings more growth back.
JOSH LIPTON: All right, let's sum this one up for viewers here. So you're telling, Ygal, investors buy Wayfair, given its current market dominance, its potential for growth. On the other side, you're saying, right here, you would avoid Etsy, as it is too reliant on discretionary consumer spending and facing competition coming from China. Thank you so much for joining us, Ygal. And thank you for watching Good Buy or Goodbye. We'll bring you new episodes three times a week at 3:30 PM Eastern. More Yahoo Finance right after this.
