SHOP - Shopify: Top E-Commerce Growth Play That I Shouldn't Miss (Rating Upgrade)

2023-08-15 08:30:30 ET

Summary

• Shopify stock pulled back nearly 25% from its mid-July highs. Given its significant growth runway, I'm excited about the opportunity to enter this time.
• The company's Q2 earnings release vindicated the outperforming potential of Shopify against its peers.
• However, SHOP's steep growth premium suggests any position needs to be managed with careful risk management strategies, mitigating unforeseen downsides.
• I make the case for why I see SHOP's growth potential as highly attractive. Coupled with improved buying sentiments over the past week, I'm ready to upgrade my thesis on SHOP.
• Comment and let me know whether you agree with my upgrade.

Investors in leading end-to-end e-commerce platform Shopify ( SHOP ) have seen SHOP underperform the S&P 500 ( SPX ) ( SPY ) since my previous caution in early May, as I urged investors to hold back from adding more positions. Notwithstanding that caution, my early January 2023 Buy rating suggests SHOP's recent pullback is nothing more than a temporary blip against its remarkable outperformance against the market in 2023.

With SHOP falling back toward its early June lows, I believe it's an appropriate time to reassess whether we have another attractive entry point into SHOP, allowing buyers who missed adding early this year to gain exposure.

Breakout investors who bought into SHOP recently anticipating a solid second-quarter or FQ2 earnings release were likely stunned. Why? Shopify reported a robust Q2 scorecard, demonstrating that it has outperformed its e-commerce peers. Shop Pay has also continued to gain traction among merchants, growing into a unique value proposition to attract merchants into Shopify's ecosystem. It also registered robust performance in B2B sales while generating upward momentum with larger merchants as Shopify continues to move upmarket.

As such, I assessed that Shopify's Q2 performance had vindicated the justification for SHOP to bottom out in October 2022. It underscored the company's growing strength in incentivizing improved product attached rates. Coupled with a revamped Shopify Audiences 2.0, the company has several potential growth drivers that have yet to be monetized fully, providing a significant growth runway.

As such, over-pessimistic investors who failed to understand the economic moat of Shopify's ecosystem advantages are urged to reconsider, given its increasing scale and network effects.

With the launch of its generative AI solutions to improve merchants' productivity, investors are expected to demand faster topline growth and improved operating leverage. I believe the decision to sell Deliverr and take a one-time impairment charge against its GAAP net income is correct. Shopify needs to invest in AI aggressively to protect its moat as it competes against big tech dedicating massive resources to gain an advantage in generative AI.

However, despite its increased focus, I don't expect AI to be a disruptive innovation for Shopify. Amazon ( AMZN ) is expected to remain a significant player in the game, limiting the disruption that Shopify could muster. However, it could still be a "sustaining innovation" if it could leverage and execute the transition well.

Despite that, Stratechery's Ben Thompson cautioned that such a benefit likely accrues to market leaders like Amazon, given their scale and well-diversified business models. Thompson added:

The companies best positioned to take advantage of AI are, in the user application space, those with the products within which AI can best be leveraged, and in the cloud space, those with the most data already on their service. AWS is very much the leader here, and it’s the biggest reason why they, along with Apple ( AAPL ), can afford to be a bit behind. - Stratechery

Therefore, I assessed the recent pullback in SHOP (down nearly 25% from its July highs through last week's lows) as a timely reminder for investors to carefully gauge SHOP's risk/reward profile. For a stock with a forward EBITDA multiple of 79.2x, it's almost certainly priced for substantial growth and robust execution. Seeking Alpha Quant's growth grade of "A+" corroborates my conviction why SHOP is the pre-eminent growth play in the space against its peers.

As such, investors must assess where are the possible key support zones that could attract dip buyers back, including speculative investors.

SHOP remains in a medium-term uptrend, suggesting it's conducive to buying the dips. Still, assessing the critical levels at where robust buying support is expected to return is essential.

I gleaned that such an opportunity exists at the current levels. However, given SHOP's aggressive valuation, I urge investors to consider any setup as speculative, executing appropriate risk management controls if the pullback is more significant than I had anticipated.

The next critical support zone is identified at the $40 level, corresponding to SHOP's late February lows. Given the buying sentiments over the past week, it's an area that looks less likely for now. However, I may upgrade my rating further into a more aggressive buying setup if it gets there.

As such, I believe the opportunity has arrived for patient SHOP holders who didn't chase the recent surge to add more positions.

Rating: Upgraded to Speculative Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating. See the additional disclosure section below for important notes accompanying the Speculative Buy rating presented.

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