Shopify's Earnings Recap

Shopify's Latest Earnings Report Recap

5/6/2023

The so-called Amazon-killer company, Shopify (Ticker: SHOP), is up more than 20% in the last few days like it's 2021 all over again. What did the company share in its latest earnings report that has investors piling up shares, and is it too late to get in on the action?
Let's talk about that!

I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of a series I started last week to research companies I own that are down significantly from their all-time highs to decide whether to buy more or sell and allocate money to other companies. I've already researched Canopy Growth (CGC), Fastly (FSLY), Snap (SNAP) and I'll continue with this series for a few more weeks.

Remember, this content is for education and sharing ideas and not advice to buy or sell any securities.

What Happened To Shopify's Stock

Shopify's story and success in the stock market are indeed fascinating. Founder and CEO Tobias Lutke started his journey to entrepreneurship from a snowboards online store to the $68B company it is today. Shopify is more than an online store platform. It enables business owners to run their entire online commerce business on Shopify. From accepting payments to shipping orders to getting loans, Shopify does it all. That's why some call it an Amazon killer.

If Amazon created the Everything Store, Shopify would make everyone an online store owner.

But killing a giant like Amazon isn't an easy task. Building the infrastructure required to accomplish such a lofty goal requires lots of capital, patience, and sustained periods of unprofitability. It's no wonder that stock price has been so volatile. The stock price has gone from $152 per share at the end of October 2021 to $27 in August 2022, experiencing an 82% drop in less than a year.
And, then from there, the stock price gradually clawed its way back up with a 23% jump this last Thursday, followed by another 7% on Friday when I'm recording the episode. It's only natural to look at the double-digit growth in one or two days and wonder whether you've missed the boat on Shopify's recovery. Even more importantly, is it reasonable to assume that the stock price can ever return to the all-time high of $152 or even higher?
Let's dig into Shopify's earnings report and see what clues the management team has left us. By the way, I own shares of Shopify indirectly through significant investment in ARK Invest's flagship ETF ARKK which has 5% of its fund allocated to the stock.

Shopify's Latest Earnings Report

The most important update from the latest earnings report is the company's divestiture of its logistics business. This is a part of the company's operations that enables Shopify customers to deliver their products to the doorstep of their customers. The company is selling this part of its business to Flexport, a logistics company, in exchange for 13% equity ownership in that company. Flexport is a private company we can't invest in, but I wish we could have. These types of businesses are typically very stable and profitable. Back to Shopify, it won't lose its logistic operations. Flexport stays a preferred logistics partner, but the move makes Shopify focused on its core, profitable software business. This is a good move, preventing Shopify from significant capital expenditure in physical shipping and logistics operations.

It's also another good sign and an indicator of management's ability to move fast. Shopify acquired Deliverr in 2022 to strengthen its logistic business. But in less than a year, it decided to leave that business. I interpret that as the management team's ability and courage to move fast if its earlier decision wasn't panning out at planned.

Shopify's Top Line:
Aside from the logistic business, Shopify reported a 25% revenue growth in Q1, higher than forecasts. Even more impressively is the improvement in a Shopify-specific metric, Attach Rate. The Attach Rate is calculated by dividing Revenue by Gross Merchandise Volume or GMV. Because Shopify is in a retail business, the value of the merchandise sold through its platform isn't equal to its revenue. However, it wants to transform a bigger portion of that Gross Merchandise Volume into its revenue. For Shopify, in Q1 2023, that rate was more than 3.04%, up from 2.79% in 2022. This means Shopify customers use more of Shoipify's systems and solutions to run their business, attaching their success to Shopify. A good example is the growing volume of Shopify payments.

Shopify's Bottom Line:
Analysts were worried about losses and negative free cash flow in the last quarterly earnings report. I reviewed that earnings call back then and remember Shopify management scoffing over the analysts' comments and saying that returning to positive free cash flow and profitability isn't a problem. I leave a link to that video in the show notes if you want to go back to it. The good news is that Shopify made good on its promise and generated $86M in free cash flow, up from negative free cash flow of $41M last year. Even more impressive is the management's forecast of free cash flow profitability for each quarter of 2023. Wow! They are giving the analysts and shareholders what they like to see.

Shopify's Balance Sheet:
Aside from the top and bottom lines, the company's solid balance sheet is the next important factor. Shopify has nearly $6B in cash and cash equivalent against $1.6B in liabilities. So even if it isn't profitable for a while, it has the cash to allocate to its future growth.

Risks Of Investing in Shopify

When a company is doing this well, investors take note. At a 13 times price-to-sales ratio, investors expect Shopify to become 13 times bigger from here. That's a high expectation to live up to. Shopify is a $70B company. A 13X growth means almost $900B in market cap, 90% of Amazon's current $1T market cap. And Amazon has a profitable AWS and a growing advertising business, above and beyond eCommerce. So, Shopify isn't a cheap stock by no means, even if at the current price of $61 per share, 60% lower than its all-time high of $150 per share.
The other thing that makes me think twice before investing in Shopify is the mention of ChatGPT in the earnings report. The company talks about integrating ChatGPT AI capabilities into its product. There is no reason for a company as focused as Shopify to run after the hype. Maybe I'm too critical, and Shopify has to say something about AI because of investors' interest, but I don't like companies chasing hype.
Another risk is Shopify's growing R&D expenses. While the company is free cash flow positive, its operations aren't profitable, partially due to a significant increase in research and development expenses. This means the company is still building its product, and that's a risk we shouldn't forget.
Lastly, we can't ignore the risk in Shopify's plan to increase its subscription prices in the coming months. On the surface, that's a good thing. More revenue for Shopify. But what if customers do not want to pay the higher prices and stop their subscriptions? That would be a good test to confirm whether Shopify has price power over its customers. If customers don't churn in the face of a price increase, it means they deem their success to be reliant on Shopify, and that strengthens Shopify's competitive moat, so critical for its long-term success.

Recap of Shopify's Fundamental Analysis

Let's recap Shopify's fundamental analysis:

Revenue is growing
The company is unprofitable, and it is increasing its R&D drastically
It has a solid balance sheet with significant cash and no liability concerns
It generates free cash flow
It is priced quite expensively using a P/S valuation ratio
The management is showing solid signs of leadership with difficult decisions such as backing out of the logistics business

Knowing all that, what should we do with the shares? Have we lost the chance to get in at a good price?

Without a doubt, if you are an investor in solid companies for the long term, you should always have Shopify on your watchlist for picking up shares when it hits lower valuation multiples like what we saw in October 2022.

You can own shares of Shopify indirectly through investment in an ETF that is betting big on the company, like ARKK or one of the ETFs in that family of ETFs. That's what I'm doing. Because even if the ETF is wrong about Shopify, there are still other companies to compensate for that mistake in the long run. This allows me to keep cash for those smaller, 100-bagger stocks I'm always keeping my eyes open for.

Those are the two things I would do. But, certainly, we have seen the market can get exuberant about companies that keep on growing and also generating cash. Shopify is indeed one such company that can potentially excite investors well above the normal realms of valuation logic. You haven't yet missed the boat if you believe that. Just expect a massive price swing. The higher the valuation, the harder the fall with even small bad news.
Look up Shopify's Stock Card to start your research, and share your thoughts in the comments so we can all learn from each other.

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