CA - The 'New' Shopify Is Here

2024-01-09 11:51:04 ET

Summary

• Shopify aims to become the go-to retail operating system for businesses as the retail landscape shifts towards channel independence.
• The "New" Shopify is not prioritizing growth at all costs but shifting to an optimized and profitable growth model.
• Shopify's use of AI and expansion of its ecosystem is allowing merchants to scale their business globally & will deliver major tailwinds for the business.

What is the Goal of this Article?

My readers know I value their time and I like to start my writings by first explaining the goals and value I hope to deliver in the article. So, let’s begin, the retail landscape is undergoing a monumental shift, as it is becoming increasingly channel independent and customers are demanding to be able to make purchases from their medium of choice. I believe Shopify ( SHOP ) has the most robust ecosystem of technology and partnerships to enable merchants to achieve this channel independence.

My goal is share how these changes to Shopify's business model and ecosystem will drive long-term growth and profitability for the company. We will examine how deciding if the stock is cheap or overvalued, cannot be accurately determined by a metric or two. If you just made that decision based off a few valuation metrics you may feel it is too expensive and miss out on a great opportunity for a stock poised for long-term rewards.

The Core of Shopify's Business Model

Today customers demand flexibility to make purchases across various platforms, including social media, online stores, and physical retail outlets. Shopify has emerged as a pivotal player, aiming to become the go-to retail operating system for entrepreneurs, small and medium-sized businesses (SMBs), and large corporations alike. I believe that the new features Shopify has created will enable their customers to grow at a speed and scale that they could not achieve before. I also believe the impact of this growth cannot yet be fully predicted because many of these features are not even a year old.

This is only a part of what the “New” Shopify is built upon but is core and at the heart of Shopify's strategy by developing a deep understanding of customer demand for optionality and convenience.

Shopify’s flywheel business model is built on their merchant’s business success and growth. This symbiotic and customer-centric relationship ensures that the company puts the customer and merchant experience first before profit if they want to achieve long term sustainable growth. I love business models like this because they are mission driven and if you deliver quantifiable ROI to your customers, they will stay with you and spend more. We will review this with their previous Q3 earnings and Black Friday results in Q4.

What is the “New” Shopify?

Shopify is not a new business but there is a new way Founder CEO Tobi Lütke, and President Harley Finkelstein is running the company. Shopify was founded in 2006 and went public 9 years later in 2015. Since inception Shopify was following a similar business model to its competitor Amazon with growth at all costs being the priority and profit later. This model worked well during times of 0% interest rates as well as during the time of COVID-19 where everyone depended on e-commerce to get their goods. Shopify was ready to take the next big jump for its business and build out a logistics eco-system to directly compete with Amazon on all fronts and hired massive amounts of staff from 2019 to 2023, nearly tripling its employee count. Part of the growing headcount came from the near total of $2.6B in acquisitions of 6 River Systems, a robotic warehouse company and the logistics startup company Deliverr.

Now you know the rest of the story and what happened in the macroeconomic downturn globally for the past two years which also resulted in interest rates to sky rocket.

This forced Shopify’s leadership team to make difficult decisions and further analyze the amount of capital and time it would take to build a logistics ecosystem internally that was comparable to those of Amazon ( AMZN ). Shopify understood quickly that the climate for growth at any cost was over, especially with Wall Street and that profitable growth had to be a focus. As a result, after a year of having the Shopify logistics business it would later be sold, which was main contributor to a subsequent reduction of employee count by nearly 23%.

Shopify made the decision to closer partner with Flexport and sell Shopify's logistics business to them, which included Deliverr. Shopify did gain 13% additional ownership of the privately owned Flexport, which could yield fruitful when they IPO. Shopify also sold 6 River Systems for an undisclosed amount to the U.K. automated grocery-fulfillment company, Ocado Group.

How is the “New” Shopify performing?

Shopify President Harley Finkelstein said it best on what this “New” Shopify is, “We are balancing our operational ambition with financial discipline”. I applaud Shopify’s leadership team for making this pivot, owning any mistakes made, and the results from these changes have come to fruition these past four quarters. Shopify’s stock is up to $71.82 as of this writing which is twice what the stock price was 12 months ago. I believe we will see even better results than the most recenter quarter beat Shopify had in Q3. In the last earnings report for Q3 the company reported a significant 25% year-over-year revenue increase at $1.7 billion, with gross profit soaring by 36% to $901 million. Analysts expected a Gross Merchandise Volume (GMV) growth of the teens year over year, but Shopify delivered a surprise of 22% to $56.2 billion. Merchant Solutions revenue increased 24% to $1.2 billion compared to the prior year, driven primarily by the growth of GMV and Shopify Payments.

Subscription Solutions revenue increased 29% year over year to $486 million, driven primarily by more merchants joining the platform and the pricing changes that went into effect for existing merchants on our Standard subscription plans. This was Shopify’s first price raise in over 14 years and was a 33% increase for the standard subscription plans, and the company did not have a meaningful loss of customers showcasing the value they deliver. Shopify’s execution and value they deliver was confirmed by third party analyst Gartner as Shopify was named a leader in the 2023 Gartner Magic Quadrant for Digital Commerce.

Notably, Shopify's strategic decision to divest its logistics business to Flexport marked a pivotal moment, allowing the company to concentrate on profitable growth. This shift reflects Shopify's commitment to sustainability and profitability, rather than pursuing growth at any cost. The company's resilience is further underscored by its positive free cash flow for the fourth consecutive quarter, reaching $276 million which was an impressive 16% of revenue. This compared to a negative free cash flow of $148 million, or negative free cash flow margin of 11%, in the third quarter of 2022. Shopify’s operating income was at a loss last year of $346 million and improved to a positive $122 million this past quarter a year later. The projected capital expenditures for the full year of 2023 are $45 million and of this $33 million was related to the logistics business they sold off. Shopify choosing to not own a logistics business but partner with Flexport and Amazon ((AMZN)) with their Buy with Prime feature, was the right choice for the business.

What are the bears saying? Is there Risk?

There is always risk with owning shares of a stock, but the risk is relative to what the shareholder’s goal is for that equity, the time frame they have given themselves to reach that goal, and their personal financial condition if they were to lose it all. I say this because Shopify has run up 101% in the last 12 months, so the likelihood it runs another 101% in the next year is not probable, but it could still beat the market average return of 10%. I believe this based on the consistent trends and projected growth in revenue, Free-Cash-Flow, and net income. Bears on the stock may say the following:

• Shopify is not profitable and is expensive trading at a price to sales of 14.
• Shopify is due for a pull back as the RSI is at 67 near over bought status.
• The state of the consumer continuing to spend like this can slow down, impacting Shopify.
• Shopify has had negative earnings growth for most its time in the public markets.
• In the last 3 months the company has had over 241,000 shares sold by insiders.

However, I would say that most of these risks are short-term at best and will impact you much greater if you are not planning to hold the stock for the next three to five years. If you look at Shopify's Price to Sales Ratio over the course of the last several years, you can see that Shopify is trading significantly lower then before.

I believe the P/S ratio is a much more appropriate metric to use than a subjective DCF, especially when we do not have a large enough sample size of EBIT to get a somewhat accurate projection. The volatility of this stock is high as it has a 5yr monthly average of 2.23 ( per Yahoo Finance ). This means the increases and decreases are much larger, so you need to review the overall trend history of the stock and since the IPO 8 years ago it has returned over 2,700% to shareholders.

Look at the graphic below that shows the difference of the last five years annual earnings growth at -32.3% vs. the past year at 64.2%. So, you have to ask yourself is the business poised for expansion and committed to profitable growth? I believe this is a trend we will continue to see and the leadership team understands this is vital for shareholder return appreciation.

What Catalysts and Expansion can the Shopify Ecosystem Capture?

This recent Black Friday and Cyber Monday weekend in Q4 was Shopify’s best ever at $9.3 Billion in Sales representing 24% year over year growth ( per Shopify's press release in late November ). Over 61 million consumers globally purchased from brands powered by Shopify and yet Shopify has captured less than 1% market share of global retail sales. According to Shopify in their Investor Day Presentation, the global TAM that they are fighting for is over $849 billion! Shopify understands there are so many more countries to democratize with “Commerce Everywhere” and this is why they have continued to create more services and products that enable their merchants to expand their global footprint. Shopify has transformed over these past years from just e-commerce to offline and B2B sales, to social commerce, and now leveraging AI with Merchant Services.

We’ve established how Shopify’s business model is a flywheel that is built at its core on enabling Shopify’s merchants to be successful and focus on their business opposed to the operations that run the business. Shopify is enabling this and driving this for its merchants by providing it’s AI suite Shopify Magic for free. Shopify Magic is a suite of free AI-enabled features that are integrated across Shopify’s products and workflows giving back time to the merchant to focus on what is important to their business. Shopify Magic was built to give merchants the capabilities that only the big Enterprise AI companies have, democratizing the benefits of AI to provide personalized, contextually relevant support for a range of tasks across store building, marketing, customer support, and back-office management. I believe this is a feature that is not monetized today but could become a meaningful revenue expansion play once Shopify identifies the quantifiable value its proving for merchants. For now, the adoption of using these AI services and ensuring value is delivered for the merchants is the first priority.

As you can see innovation remains at the core of Shopify's strategy. The launch of Shopify Markets Pro this past Q3 is a testament to the company's commitment to helping its merchants scale cross-borders. This feature enables sellers to effortlessly expand into international markets, offering localized marketing and currency options. With Shopify's presence in over 175 countries and support for 20 languages, the potential market is vast. These capabilities are indispensable to small and medium businesses who would not be able to scale at these levels, if it weren't for Shopify Markets Pro. The turn key capabilities of this solution also are attractive for Shopify's larger enterprise customers who are on their Shopify Plus platform. The platform's reach, coupled with the burgeoning global e-commerce market projected to hit $7 trillion by 2025, positions Shopify favorably for continued expansion and market penetration across merchants of all sizes.

Shopify understands the power of “Commerce Everywhere” and different countries need different GTMs and capabilities. Some merchants will excel with delivering their business offline in store-fronts, others will be online or social media, regardless of what merchants need, Shopify has a solution for them. A pivotal aspect of Shopify’s strategy is its flywheel ecosystem, designed to empower their merchants and drive their success at scale globally. This ecosystem encompasses various elements, from providing user-friendly interfaces and comprehensive analytics tools to offering extensive support through its Shopify App Store, which features over 8,000 apps. By enabling merchants to enhance their online stores with these apps, Shopify not only improves their business outcomes but also reinforces its own platform’s indispensability.

In Summary:

It may be hard for some Shopify investors to increase their position in the stock since it has quickly risen over 101% in the last 12 months, and may be cautious of a pullback. However if you have a long-term horizon and believe in patiently dollar cost averaging to grow your positions or when starting a new one, I don't see as much risk here. As you can see from the graphic below, almost 1/3 of the 31 analysts covering Shopify see the stock going higher in the next 12 months and 19 analysts are holding and believe it will stay at these prices.

What I focus on opposed to short term price targets are asking myself qualitative questions around the business. These qualitative questions in my opinion if answered with a 'Yes' increase my conviction for a stock's success in the long term much more than any kind of valuation forecast. Here are some of the questions below that I would ask and Shopify has a 'Yes' for most of these.

• Does the company have a competitive advantage in a growing and emerging global market?
• Is the company solving meaningful problems that impact a global market?
• Is the company founder-led and does the leadership team have a good size of ownership in shares? is there compensation aligned with shareholders?
• Is the company mission driven and the founder have a clear vision for the future of the company?
• Does the company pass the "Snap Test?" if I snap my fingers tomorrow and the company was gone, would a large population notice?
• Can the company grow their margins above 50%?
• Can the leadership team own when mistakes occur and pivot the business accordingly to get back to exceeding their goals?
• Has the company shown good financial stewardship when making investments & R&D? and do I see a path for profit and revenue to rise double-digits?

Shopify's shift from growth at all costs to a higher focus on optimized and profitable growth is the turning point shareholders will remember when they look back years from today. In order to benefit from this shareholders will need to be willing to weather the inherent volatility of Shopify as it navigates the needs of its merchants and a rapidly evolving marketplace.

For me personally, the pivots that Shopify’s leadership team has made demonstrate they understand when change is needed and can execute quickly. In my opinion their investment in the developer community and their merchant’s success is their guiding north star that will help them capture this immense TAM. I believe there are several platforms in the Shopify ecosystem that are not priced in the stock and will drive immense value for their merchants which will impact the stock price over time.

I encourage readers to pay attention to the growth and leadership commentary around Shopify Markets Pro, the new AI solutions Magic and Sidekick, Shopify's growth into social commerce, and Shopify Plus (platform for Enterprises). Shopify is consistently expanding how its merchants can deliver commerce everywhere and gives me confidence there is still plenty of room for this company to innovate and the stock to rise. Companies that invest in their customers’ business outcomes and enable their success, will ultimately win in the long run and reward their shareholders.

For further details see: