Shopify: Momentum Risk, Outsized Gain

Nov. 20, 2019 6:03 AM ETShopify Inc. (SHOP), SHOP:CA90 Comments6 Likes
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Douglas Adams


  • Shopify is up just over 130% YTD, about 5 times the S&P 500 gain through the second week of November, despite falling into bear territory since peaking in late August.
  • The company fell into the crossfire of an equities selloff and a bond rally as the dark clouds of economic uncertainty enveloped markets in September and October.
  • Economic fundamentals signaled otherwise, as market sentiment abruptly changed, providing a fecund environment for further market momentum.

Toronto-based Shopify (NYSE:SHOP) is an online e-commerce platform that offers turnkey online, management and, most recently, fulfillment solutions to small- and medium-sized businesses. The company now boasts over 800,000 merchants in 175 countries around the world. Through Monday’s market close, SHOP is up just over 130% YTD, outpacing the S&P 500 benchmark by more than five-fold through Tuesday’s market close (Nov 19). The company has doubled its market capitalization to just over $37 billion, surpassing eBay (EBAY) on the measure earlier this year. SHOP is now on the verge of surpassing eBay in total merchant sales in the all-important US market from which over 70% of the company’s revenue derives.

Since hitting its peak stock price for the year on the 27th of August, however, SHOP has fallen into bear territory at just over 22% as market momentum deflated in much of September in the face of an equities selloff and bond rally that darkened skies with global economic uncertainty. Shopify share price fell through its lower trend line of support, shredding an upside Ichimoku cloud whose origin breakout point dates back to mid-January (see Figure 1 upper frame, below). SHOP’s plunge into bear territory appeared oversold in the latter part of September (lower frame), as the company’s market fortunes see-sawed through much of October and into November.

Figure 1: Shopify against the S&P 500

In spite of this rough patch, SHOP’s consistent double-digit revenue growth remains impressive and gets to the heart of the stock’s current market momentum, despite fair market valuations running at roughly half the current share price. The company’s 5-year compounded annualized growth rate since its 2015 IPO is just under 60% through the end of 2018. By way of comparison, tightly integrated e-commerce platforms from competitors such as Amazon (AMZN) grew at an annualized rate of just over 21%. (CRM) posted 19.23%. Adobe (ADBE) put up 19.84% over the five-year period. eBay (EBAY) grew at a scant 4.1%. Aggregate S&P revenue at the conclusion of the current earnings season fared far worse at 3.2% YOY - the slowest pace since the 3rd quarter of 2016. Arguably, there is little evidence to bring to the fore - short of a broad-based economic downturn - that would threaten SHOP’s double-digit revenue growth for the foreseeable future. SHOP’s revenue growth should drive its share price back to the company’s August high of $400 by year’s end 2020, and here’s why.

Robust consumer spending, low inflation, historically low borrowing costs and 3%+ annualized wage growth provides a pretty fecund environment for any momentum stock. Consumer spending is clearly driving annualized US output over the past five years with a high of 3.7% YOY (2015) and a low of 2.6 YOY (2017). Consumer spending was 3% YOY through the end of 2018, hitting a high of 4.7% in the 2nd quarter of 2019 before slipping to 2.9% on a quarter-to-quarter basis through the first estimate of GDP growth through September. Global consumer spending has been further bolstered by continuing synchronized monetary easing courtesy of central banks across the globe, producing some of the lowest borrowing costs for corporate and household decision makers in the post-WWII era.

Here in the US, a spinoff of the Fed’s various asset buying programs has been a 50-year low in the US unemployment rate, curiously coupled with scant price inflation in the broader economy. A contributing factor is the anemic demand and, consequently, an abundant supply of oil on global markets, with demand sketching out its slowest pace since the financial crisis. Efforts to limit production by OPEC have proved less than fruitful in lifting global oil prices. Even with US sanctions on Iranian and Venezuelan production, coupled with the September drone attack on Saudi oil processing facilities that temporarily knocked out more than half of the country’s production, the impact on prices has been surprisingly minimal. US shale production in September, which was 12% higher YOY, continues to provide more than enough production to maintain downward pressure on prices across advanced global markets. That pace is expected to rise to 16% YOY by the end of 2019. The US benchmark hasn’t traded above $60/barrel since mid-September, and only then in response to the drone strikes on the Saudi Aramco (ARMCO) facilities at Abqaiq and Khurais in the eastern part of the country. Moving forward, OPEC’s current 1.2 million b/d production cuts that carry through March 2020 may be insufficient to keep Brent crude above $60/barrel.

Core PCE inflation has yet to breach the Fed’s 2% annualized inflation threshold through the end of 2018, with 2019 more than likely to follow suit. Market-based inflation expectations 10 years into the future have risen to roughly 1.63% at today’s market close, a gain of about 10 b/p on yields posted at the end of October. At the same time, disposable income in current dollars is at 6.1% annualized through the end of 2018. Holdings of cash fell to 4.2% for investors during the month, the steepest monthly drop since 2013, as the decade-old bull market regains its footing after a late summer tempest.

The global equity selloff and offsetting bond rally in the late September-early October period was surprising given how little the economy has changed between the September and October meetings of the Federal Open Market Committee (OTCPK:FOMC). The target range of the Federal funds rate settled at 150 basis points to 175 b/p with the year’s third rate reduction at October’s FOMC meeting. With 75 b/p lopped off the Fed funds rate since July, market expectations that the current range will remain intact for the balance of the year and the near-term beyond are just shy of 100%. The S&P 500 hit another record high at the end of last week on equity fund inflows as the American Association of Individual Investors’ weekly survey captured the largest bullish sentiment shift since January 2018. While survey data still places US manufacturing and German industrial production in contraction largely on continuing trade tensions across the Pacific and looming tensions across the Pond, the 10-year Treasury yield soared to a four-month high of 1.93% last week - one of the clearest signs yet that investors’ fears of recession are on the wane. In early September, the yield on the 10-year Treasury was 1.461%, a mere 10 b/p from its all-time low post of 1.36% in 2016. That said, few analysts expect the yield of the 10-year Treasury note to hit 3% anytime soon, as slow global economic growth and the difference between bond yields in the US with similar maturities in Asia and Europe will likely continue to place downward pressure on US bond yields for the foreseeable future. Along the way, the US yield curve quietly "un-inverted" in mid-October - no matter that the predictive powers of the yield curve may not be as catholic in the age of large-scale asset programs. And for good measure, the VIX volatility index is down to 12.86 at today’s market close, well off its historical average reading of around 20.

And let’s not forget October’s 0.3% uptick on September or a 3.1% YOY increase in retail sales. Consumer purchases of cars, goods from general merchandise stores and online purchases grew by 0.5%, 0.4% and 0.9%, respectively. Online purchases are expected to do well in the coming holiday shopping period with more than 41% of consumers planning to make at least half of their purchases from their living rooms or office desk computers. Consumer spending, about 70% of total US output, appears largely intact. Perhaps investors were a bit too hasty in bolting for the exits last month. What can be gleaned from recent Fed statements is this: without a sharp increase in inflation over the near-term, the Federal funds rate will likely remain in its current range for the foreseeable future. The lag time for the Fed’s most recent rate moves will extend well into 2020 before recent rate changes impact the greater economy. This means more investor appetite for stocks and other risk assets, which is bringing a cache of investable cash from the sidelines and into market play. The decade-long bull market continues. All of this bodes well for further consumer spending and Shopify revenue growth in the all-important US market as well as further afield.

SHOP operates through two segments: subscriptions and merchant solutions. Subscriptions include monthly, annual or multi-year software access to the company’s e-commerce platform, comprising about 43% of company revenue through the end of 2018. Subscription revenue also includes fees for the sale of customized merchant themes, apps and the registration of domain names. The company’s application program interface now has over 3,200 apps through the end of September. These apps allow merchants to display, manage and sell their wares over a variety of sales channels, including web and mobile storefronts, bricks-and-mortar locations, pop-up stores, social media storefronts and marketplaces - basically anywhere within digital reach of the consumer and in an ever-growing array of languages. Subscription revenue has a compounded annual rate of growth of almost 42% from September 2015 through September 2019, posting $165,577 million in sales. Subscription sales should post in the neighborhood of $212,000 million by September 2020 for a projected 28% YOY increase.

Merchant solutions generate the bulk of its revenue from credit card processing fees transacted through Shopify Payments, which is itself driven by an ever-growing array of revenue streams, including the number of merchants on the platform, the volume of goods processed through the platform and now the volume of inventory and number of orders that pass through the Shopify fulfillment network. Additional funds for the revenue segment derive from third-party partners, Shopify Capital, as well as point-of-sale supplied hardware. About 90% of merchants on the platform use Shopify Payments, while about 40% use Shopify shipping. Merchant solutions revenue posted a CAGR of 57.48% through the end of September on $224,975 million in total sales. Merchant solutions revenue should project out at just over $299,000 through September 2020, or 33% YOY.

While basic merchant subscription plans are as low as $29/month and with an undefined bulk of subscription rates weighing in around $50/month, the issue of YOY retention and small business failure rates is more than an ongoing concern. About 20% of all small businesses fail in their first year, while 30% fail in their second year of operation. A further 50% fail after five years, and about 70% fail in their tenth year, according to national statistics. A persistent and stubborn merchant churn results. Unsurprisingly, the company does not supply a churn rate in its official reporting. It goes without saying that subscription retention remains necessarily problematic at the small end of the Shopify platform. That said, digital business-to-consumer commerce has comparatively lower barriers of entry than a traditional bricks-and-mortar retail outlet, which speaks to the ever-growing vacancy rate in the nation’s malls, particularly in rural America. Digital stores clearly require less initial capital outlay, which provides more of a draw to would-be entrepreneurs wanting to sell their wares to the consuming public. Shopify supplies continuing turnkey access that allows a steady flow of retailers at all levels of entry to try their hand at making their ideas and brands work that would otherwise not be possible. That the company’s subscription business has a CAGR of 42% over the past five years and speaks loudly to realization that platform upstarts continue to outpace platform failures by wide margins for the period.

More advanced plans for larger businesses come to about $299/month. Shopify Plus includes over 5,000 larger businesses with high sales volumes on variable payment schedules. Here, platform integration pushes subscription attrition rates to 10% or less, on par with those found on high-end enterprise business platforms such as

SHOP has all the makings to play at the high end of enterprise business platforms, to which its current market attention attests. On a GAAP basis, the company is still generating negative operating income at ($35,658) million, or 9% of total revenue through the end of September. Net GAAP loss came to ($72,784) million, or 19% of total revenue over the period, for a net loss of (0.64) per outstanding share. Positive GAAP operating margins are still in the future, with the most likely target date being calendar year 2023. Until that time, company and investors alike will continue to chase less-traditional measures of growth.

This article was written by

Douglas Adams profile picture
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.

Disclosure: I am/we are long 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.

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