Shopify: Great Results Again

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About: Shopify (SHOP)
by: From Growth to Value
Summary

Shopify reported earnings premarket on Tuesday February 12, and the company beat all expectations again.

The stock price fell considerably, but then ended in the green at the end of the day.

The company is just in the first innings of its story. It invests in future growth and does all the right things to keep doing that.

Introduction

Shopify Shopify results Q4 FY 2018

(Image Source)

On February 12, 2019, Shopify (SHOP) announced its Q4 2018 earnings pre-market. The company is a serial over-deliverer, with positive earnings surprises in every quarter. You can see this on the chart provided by Zacks: all the lines are green, indicating beats.

And yes, a new green arrow can be added to the graph: the company did it again, beating the expectations on all metrics. The Q4 non-GAAP EPS of $0.26 beat by $0.05, an outperformance of 24%. The GAAP EPS of -$0.01 beat by $0.07 too, beating the consensus out of the park. Revenue came in at $343.86 million, beating the consensus by $16.43 million (almost 5%) and growing 54.3% YoY. Great results, in my book.

But still, at a certain moment, the shares were down by almost 10% pre-market. I want investors to hold their eyes on the road and ignore the multi-colored naysayers that try to distract you from the path to a multibagger.

The reason for Shopify's volatility

Shopify has been quite a volatile stock over the last year or so, as you can see from this graph:

Chart Data by YCharts

The reason is that the stock has become the target of traders. As you all know, traders play on short-term price moves, and there are enough to let Shopify jump up and down like a young mountain goat.

But why has it become a favorite playtoy of traders? As often, there are several reasons, but let's highlight the two most important ones.

The first reason is that Shopify is, of course, highly valued. With a forward P/E of 251 (according to Finviz), there is no doubt that it is priced for perfection. But a lot of people forget that this is a company in the technology sector. There are a lot of front-loaded costs, and once you have the scale, you become more and more profitable.

I don't think there is any doubt that Shopify is on a winning streak in the scaling game. Once a customer is into the Shopify environment, the upscaling cycle can take place, although you don't want to do that too bluntly. You have to look at Customer Lifetime Value, or CLV. Once somebody deserves money with Shopify, she will be open to upgrade to a more expensive product and earn even more or have more services. Shopify bears get it all wrong, in my opinion, by emphasizing the churn (which, by the way, is completely unknown to them too). If you have 10 clients and you can only keep 5, but those 5 do not only stay very loyal clients but buy upscale after upscale, what's the problem exactly? Oh, and I think the churn is actually a lot less than 5 out of 10.

The second reason is that a few high-profile shorters have taken aim at Shopify. Most notably is, of course, the case of Andrew Left of Citron Research. I still wonder where his "smoking gun" is that Shopify is a pyramid scheme. Or where the "Big Facebook Problem" is that Shopify was supposed to have. If there is a Facebook (FB) problem, it is within Facebook itself, not for Shopify.

Anyway, what I mean is that more shorters followed these kinds of calls, and despite the big surge in the stock price of Shopify lately (ouch, shorters!), there are still 8% to 10% of the shares short (the sources vary). So, if the stock goes down again, you know that new shorters may have jumped in. Mind you, this is not aimed at shorters - I like those guys! They are the ones who bring prices down and bring liquidity in the markets. They should be the best friends of long-term investors, in my opinion.

Shopify's Q4 2018 highlights

Despite the beats on all metrics, Shopify shares dropped by as much as 10% pre-market. Shorters trying to bring the stock down? Traders taking profit? It doesn't matter in the end. Because in the end, if you look at the company, it performs well on every metric. As CEO Tobi Lütke announced:

We made history in 2018: no other SaaS company has crossed the $1 billion-dollar revenue mark at a faster growth rate than Shopify has.

I think this says something about Shopify's strength. The CEO added:

This milestone is significant due to the backdrop: Shopify allows people to partake in the entrepreneurial world who would otherwise not be able to do so. We have been focused on growing this market for the past 12 years even though a lot of people told us that this isn’t a valuable business model. We let the results speak for themselves.

Indeed, results are much better than words.

On the Q4 2018 earnings call, a proud COO Harley Finkelstein first looked back on 2018 and was very pleased with the company's new products:

The features that our product team shipped this year were geared towards achieving this; multilocation inventory, Shopify Ping and our Centralized Marketing Dashboard helps streamline operations, while Dynamic Checkout and new discount features are designed to enable merchants to personalize a buyers purchase experience and increase sales conversions.

Finkelstein followed that pride with some namedropping: Johnson & Johnson (JNJ), Unilever (UL), Procter & Gamble (PG), and General Mills (GIS) are all Shopify Plus clients, just as the Obama Foundation, Tom Brady's brand TB12, and Ladder, founded by Arnold Schwarzenegger, Cindy Crawford, Lindsey Vonn, and LeBron James.

But probably much more important is that Shopify was launched in extra languages in 2018, so the total stands at seven now. Finkelstein again on the Q4 2018 earnings call:

As such, merchants from outside our core Geos accounted for 24% of our merchant base 2018 up from 21% in 2017. And the contribution from international merchants to total GMV on our platform continued to increase with the GMV more than doubling over 2017 in three out of our four priority countries.

The core geographies are, of course, the USA, Canada, the UK and Australia. This shows that there are huge international growth opportunities left for the company.

Shopify has accumulated $2.13 billion in cash, cash equivalents and marketable securities on its balance sheet, which makes it look like it could be eyeing an acquisition or that the company is hoarding cash for a market downturn to buy on the cheap. And the company has no debt, so it could take on credit to make a splash acquisition. Or a few smaller acquisitions, of course. The most extra cash (some $390 million) came from a share offering in December 2018. CFO Amy Shapero said on the Q4 2018 earnings call about the big cash stash:

We fully expect the cash on the balance sheet from the capital raises to be used to achieve our business strategies which will likely include M&A. If we see an attractive opportunity to accelerate or our product roadmap we will certainly pursue it.

A small part of the earnings surprise can certainly be attributed to cannabis sales now that Canada has allowed the trade of recreational cannabis. This will have resulted in more subscriptions and GMV growth for Shopify. But the full effect of cannabis is not into the company's numbers yet, since there is a serious shortage of cannabis, and that shortage could be for years. But Shopify has the strong will to be the most dominant player in Canada and to be the logical choice for other countries too once cannabis is legalized there. COO Harley Finkelstein on the Q4 2018 earnings call:

So part of it, just to be clear, the reason that we were so aggressive in going after the Canadian cannabis market was, we felt that – what the Canadian Government was legislating was very clear and it made it easy for us to understand what was required, but what it also did was it also positioned us if we did this right to be a global leader and be the first phone call that any other country thinks about when they're thinking about regulating or allowing cannabis sales to the consumer to be to be allowed.

The company’s revenue grew by 54.3% YoY versus Q4 2018. Some analysts might use that to conclude that Shopify will drop because the revenue growth declined. But I don't agree. For a company with a market cap of $19 billion, 54% revenue growth is enormous. The law of large numbers says that big companies cannot keep up that growth pace forever. But I think even a lot of start-ups would sign any time if promised to have 54% YoY growth even for a few years. I expect the growth to come down in percentages, but that doesn't matter all too much at this point.

Some analysts ascribed the drop after earnings to a miss on operating income, but I think this is just looking for a reason, since the results overall were very strong. Besides that, operating income was up 72% YoY, nothing to sneeze at. The main reason for the small miss in operating income is the heavy spending the company does for innovation and product development. This is, for example, the R&D spending evolution in millions:

(Source: Shopify Q4 and FY 2018 press release)

As you can see, the R&D budget is up by 70% YoY. I think R&D is one of the best costs any company can make, since it is often the motor for innovations that generate returns for the future. Shopify's CFO Amy Shapero said on the Q4 2018 earnings call:

It's too early to talk about when we might see more operating leverage while we see opportunities for growth. We're going to continue to invest for the longtime long term as we have in the past.

Subscription solutions revenue grew strongly again, by 42% to $133.6 million, driven by new merchants. There was a total of more than 820,000 merchants on the Shopify Platform at the end of 2018. There were 5300 merchants on Shopify Plus, the premium version of Shopify, up 47% from 3600 at the end of 2017. It now contributes 25% to the monthly recurring revenue.

Monthly recurring revenue grew 37% YoY, a very respectable number, in my opinion. The main reason: new merchants. GMV (Gross Merchandise Volume, the total amount in money that is sold on the platform) grew by 54% YoY to $14 billion. A further growth in the company payments, shipping and capital also made this grow.

These numbers are all very impressive, in my opinion. Monthly recurring revenues are one of the most stable sources of income. That is the very reason Amazon (AMZN) introduced its Prime service. And the Plus clients are big spenders, adding much value to Shopify's revenue, so this is all good news.

The guidance Shopify gave was mostly in line with what the analysts had expected, but we know that the company guides very conservatively.

Company management stressed on the earnings call that it will continue to innovate and has a few new developments in the pipeline, but they didn't want to get into the specifics. CEO Tobi Lütke talked about some initiatives in augmented reality, like placing a sofa in your own living room (virtually, of course), stressing the fact that Shopify has developed the platform, but he also insisted that it is very early for AR and that it needs a lot of work.

Takeaway

This was my fourth article on Shopify, or my fifth if you include my participation in the podcast "Behind the Idea" about Shopify. I highly recommend you to subscribe to that podcast series on iTunes or whatever podcast player you use - always highly informative for everyone who loves an in-depth analysis of stocks, with the great hosts Seeking Alpha editors Daniel Shvartsman and Mike Taylor.

In my first article on Shopify, dating back to May 2017, when I introduced the stock in my series of Potential Multibaggers, I said that high-growth companies need to be looked at from a qualitative point of view.

In my second article, I connected the company with a trend in society: rising rates of entrepreneurship as a reaction to the outsourcing of more and more jobs, not only industrial but also in services.

In my third article, I tried to pierce through the curtain to the numbers and provide a valuation guide. The curtain in this case is that Shopify is growing so fast that it is impossible to apply traditional metrics, just as it has been impossible for Amazon or Netflix (NFLX) for a very long time.

In this fourth article, I looked at Shopify's Q4 and FY 2018 earnings to check if the company is still on the right track. And I am very confident that it is. The company keeps firing on all cylinders. The earnings were great again, and Shopify keeps doing all the right things to keep growing at a high pace. The fact that the stock went down considerably pre-market, was down 4-5% most of the day but ended in the green at the end of the day says to me that most investors have recognized that too. Shopify is in the first innings of its story. Don't judge it as a fully-grown company, but as a high-growth stock that keeps gobbling up more and more market share.

If you have enjoyed this article and would like to read more articles from a long-term perspective and updates about Shopify, please hit the "Follow" button next to my name.

In the meantime, keep growing!

Disclosure: I am/we are long AMZN, SHOP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.