SHOP - Shopify: Growth Continues With AI

2023-08-05 07:18:15 ET

Summary

• Shopify's CEO believes that AI will unlock unprecedented capabilities and contribute to the company's high growth in GMV and revenue.
• Shopify has introduced Shopify Magic, a suite of free AI features, including Sidekick, an AI-enabled commerce assistant.
• The increase in GMV and revenue, as well as the removal of the low-margin logistics business, are expected to drive continued growth for gross profits.

Introduction

My February article shows how Shopify’s ( SHOP ) growth has been outstanding as they improve commerce. CEO Tobi Lütke has written a letter since that time saying AI will unlock unprecedented capabilities. My thesis is that high growth in GMV and revenue will continue at Shopify as they keep figuring out more ways to help merchants with AI.

Developments

CEO Lütke wrote a letter on May 4th saying Flexport is buying Shopify Logistics which will allow Shopify to focus on improving commerce with AI:

Shopify’s main quest is to make commerce simpler, easier, more democratized, more participatory, and more common. I think that we have built the best commerce platform in the world for that. Technological progress always arcs towards simplicity, and entrepreneurs succeed more when we simplify. But now we are at the dawn of the AI era and the new capabilities that are unlocked by that are unprecedented . Shopify has the privilege of being amongst the companies with the best chances of using AI to help our customers. A copilot for entrepreneurship is now possible. Our main quest demands from us to build the best thing that is now possible, and that has just changed entirely.

Shopify Magic is a suite of free AI features integrated into the Shopify ecosystem and it was introduced at the Summer ‘23 Editions . In the 2Q23 call , President Harley Finkelstein talked about Magic saying it can help with everything including inboxes, the online store builder and merchandising. One of the most exciting parts of Magic is Sidekick, a new AI-enabled commerce assistant that is coming out soon. Here is what President Finkelstein said about Sidekick:

Merchants will now have a commerce expert in their corner who is deeply competent, incredibly intelligent and always available. With Sidekick, no matter your expertise or skill set it allows entrepreneurs to use everyday language to have conversations that jump start to the creative process, tackle time-consuming tasks and make smarter business decisions. By harnessing a deep understanding of systems and available data, Sidekick integrates seamlessly with the Shopify admin enhancing and streamlining merchant operations.

The Magic section of Shopify’s website shows an example of the type of tasks Sidekick will perform:

Among other things, a video from Summer ‘23 Editions shows an example where AI reads the body of a merchant’s email and comes up with a suggestion for the subject line of the email. AI will also help merchants answer email questions.

Valuation

We have to understand Shopify’s past growth in order to make estimates about their future growth and their valuation.

Looking at quarterly revenue from the last 5 years, both Shopify and Salesforce have grown prodigiously as merchants rely more heavily on their software. Note that the fiscal quarters for Salesforce are a year and a month different from the calendar quarters. As such, the calendar quarter of 1Q23 corresponds to the 1Q24 quarter for Salesforce ending in April 2023. Starting from a lower base, the growth rate for Shopify has been significantly higher. The 5 year revenue CAGR for Shopify from 2Q18 to 2Q23 is north of 47% as revenue skyrocketed from $245 million in 2Q18 all the way up to $1,694 million in 2Q23. Meanwhile, the 5 year revenue CAGR for Salesforce from their 1Q19 fiscal period to their 1Q24 fiscal period is above 22% as revenue climbed from $3,006 million in fiscal 1Q19 to $8,247 million in fiscal 1Q24:

One of the reasons Shopify’s revenue has gone up over the years is because their attach rate has increased. Their attach rate is revenue divided by GMV and this has climbed from 2.6% in 2018 up to 3.1% for the first half of 2023. I expect this climb to continue as Shopify uses AI to improve their offerings for commerce such that merchants will be willing to pay more money for offerings. The increase in gross payments volume (“GPV”) has been the main driver in the increased attach rate since 2018:

Of course the increase in GMV is also a big factor for the increase in revenue. Shopify’s 2Q23 GMV was $55 billion while Amazon’s 1P sales were just shy of $53 billion. 2Q23 was the first quarter ever where Shopify’s GMV came in higher than Amazon’s 1P sales:

I am optimistic that we will continue to see a high growth rate in GMV as AI offerings drive new merchants to join Shopify and existing merchants to increase their sales.

The 2Q23 release notes that the sale of the logistics business will create a 3Q23 revenue headwind of 300 to 400 basis points with respect to 3Q22 revenue. As such, 3Q23 revenue should “only” be about 22% higher than 2Q22 revenue instead of being 25 or 26% higher. The removal of the low-margin logistics business will create a gross margin tailwind of 300 to 400 basis points. Therefore, 3Q23 gross margin should be 2 to 3 percentage points higher than the 2Q23 gross margin of 49.3%.

Looking at the 2Q23 release and the 2022 annual report , trailing twelve month (“TTM”) gross profit is $3,012 million or $1,552 million + $2,754 million - $1,294 million on TTM revenue of $6,303 million or $3,202 million + $5,600 million - $2,499 million. I’m optimistic that half of gross profit can make its way down to free cash flow (“FCF”) when high growth investments stop being made through income statement lines. This would translate to a hypothetical TTM FCF of $1.5 billion through 2Q23. I can see a valuation range of up to 45 to 55x this amount which comes to a range of $68 to $83 billion. The August 4th share price is $57.93 and the 2Q23 results show 1,280,407,642 diluted shares such that the market cap is $74.2 billion. The market cap is inside an optimistic valuation range so I think the stock is a hold.

Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.

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