Shopify's Q3 Update Highlights Its Keen Understanding Of The Business

Summary

• SHOP is quickly becoming an online herald for small and medium businesses in most parts of the world.
• It shows strong growth and begins to resemble a "pure play" AMZN.
• Active interest in merchant empowerment makes it a welcoming destination for entrepreneurs and transitioning brick-and-mortar businesses.

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Shopify (NYSE:SHOP) represents the core principle of e-commerce: a nimble means of enabling businesses to connect and transact with customers far and wide while Amazon (AMZN) is a perplexing bundle of disparate massive business activities. The former is an upstart in a landscape that wasn't supposed to be quite as cut-throat.

The company's pure-play focus on e-commerce makes it a strong candidate for an investor's "core" portfolio ("core" and "satellite" portfolios were discussed in an earlier article).

The "Small Business" Challenge

In the U.N. Conference on Trade and Development (UNCTAD) list of Top 13 B2C companies as per Gross Merchandise Value (GMV), i.e. the total value of goods and services provided, Shopify showed a 96% in this value to climb 4 ranks in a single year: 2020.

Offering online retailers a suite of services that include payments, marketing, shipping and customer engagement tools, Shopify has been heralded a saviour of small businesses during the pandemic and from the monopoly of the likes of Amazon: more than 1.7 million businesses in approximately 175 countries are using the company's platform as of the end of 2020.

With the same end date, it is estimated that over 50% of all Shopify merchants were based in the United States.

Shopify's Gross Merchandise Value (GMV) had grown from a paltry $707.4 million to a whopping $119.6 billion.

457 million people bought from a Shopify store in 2020, representing a year-on-year increase of 52.33%.

The company has two streams of business: in its "Subscription Services" segment, merchants pay a monthly fee for the use of its platform for Point-Of-Sale transactions across regions and stores, as well as sales of apps, themes, and domains. Its "Merchant Solutions" segment's revenues primarily consist of payment processing fees, with referral fees, advertising revenue and sales of POS hardware also included.

Across these two segments, the company generated $2.93 billion in annual revenue in 2020, representing a year-on-year increase of 85.44%. The year is important since the company registered a whopping turnaround by posting its first ever annual operating profit of $90 million.

As of 2020, Shopify stood at the No. 2 spot in e-commerce market share in the U.S., surpassing the likes of Walmart (WMT) and eBay (EBAY).

Shopify also found an important ally against Amazon. On May 18, Google (GOOG) (GOOGL) announced a deepening of its partnership with Shopify that would make it easier for the latter's merchants to reach shoppers via Google Search, Maps, Lens, Images and YouTube. Following this announcement, the stock price popped up by around 4% on at least two consecutive days.

Now, Google's mainstay is ad revenue - which Amazon had been eating into in recent years.

This move is designed to both hit back at Amazon's growing clout in this area while partaking in the growth story of smaller online sellers.

Recommendation and Themes

Compared to Amazon, Shopify might look like a little "bare bones" offering only online transaction solutions to business. This is not true - it also operates a fulfillment center business that promises to be a thorn to Amazon's side within a couple of years. The company doesn't behold its merchants to this service and offers distributed cost savings for merchants to keep their businesses running. Also, as an "enabler" of enhanced customer reach, its overheads with regard to advertising, promotion and discounts is limited since businesses are free to do so with an eye on their bottom line. The "distribution" of these decisions to the merchant level makes the company more nimble and cost-efficient. Hence, while Credit Suisse's analyst report which cut AMZN's target price also pared down Shopify's, it was largely with regard to concerns on buying trends in an inflationary environment.

If chosen to be included by an investor, the company becomes a strong candidate for a basket with the "e-commerce" theme. Its current structure draws some parallels with Amazon but it is not nearly as confounding. One hopes that Shopify doesn't decide to start a streaming platform or buy movie studios!

An argument could be made to consider including eBay into the basket as well since it too is a merchant platform. Walmart can also be considered but it's very light in international coverage and heavy on physical stores.

The recommendation for this stock is strengthened by its financials, as seen in its Q3 update:

• The company's net income went from a loss of nearly $125 million in 2019 to a net positive of $320 million in 2020. Over the next three quarters, net income was nearly $1.3 billion in Q1, $879 million in Q2 and $1.2 billion in Q3. In YTD terms, the reported value is nearly $3.3 billion while the same period the previous year was just $196 million.
• Sales and Marketing expenses have remained steady over the 3 quarters, implying that the company's benefits don't seem to warrant extra promotion. Cost of revenues have also held fairly steady.
• A curious feature is the usage of convertible senior notes and the consistency with which they have been moderately issued over the 3 quarters, after a 20% increase in issuances from 2020. This is a strong move as it could be interpreted to mean that the business is stable and that company leadership is confident that creditors will see value in its direction.

The company also made a lot of well-timed merchant-friendly moves: early efforts to support shopping on social media channels has witnessed GMV contributions in this segment go up year-on-year; the roll-out of a money management product for U.S. merchants; a brick-and-mortar space featuring products available on the Shopify network where businesses can come and learn; forgoing its revenue share with its app developer partners; and cumulative funding for businesses via loans and cash advances is at an all-time high of $2.7 billion. These measures imply a keen understanding of what drives a merchant to stay loyal to a platform in a world of options: service and support.

One item in the announcements listed was very interesting: the launch of a centralized platform, Shopify Markets, to facilitate merchants' cross-border access. In effect, the "back-end" resembles that of Amazon's shopping portal which automatically facilitates international shipping wherever available. This is a powerful tool to give to merchants. Not listing on Amazon but on their own Shopify-enabled website gives them an edge in branding while retaining customer focus.

Despite falling short of market expectations, some analysts have explained this away by saying that investors had already "built" this into the share price. Investors should capitalize on this opportunity to buy into a long-term opportunity.

Plays

Given that Shopify is increasingly shaping up to the "pure play" version of the bewilderingly-structured Amazon, a comparison in stock performance would be in order. Comparing the normalized stock performance of Amazon and Shopify versus the benchmark S&P 500 (SPX) in the YTD until the weekend before the Q3 update shows an unsurprising (by now) trend.

Shopify actually outperforms the benchmark unlike its rival - which lags by quite a margin. The jaggedness of the former's trajectory is likely a function of both investor uncertainty over the survivability of small businesses coupled with inflation concerns. However, if the reports given by the company regarding the growth in GMV over the past three quarters is anything to go by, the ecosystem of smaller businesses is alive, healthy and growing in value online.

The company's unobtrusive, steady and ever-present support of this ecosystem around the world will likely enable it to continue to deliver growth as well as hold (and deliver) value over a long-term horizon. For that, the company receives a strong recommendation.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

I lead research at an ETP issuer that offers daily-rebalanced products in leveraged/unleveraged/inverse/inverse leveraged factors with various stocks, including some mentioned in this article, underlying them. As an issuer, we don't care how the market moves; our AUM is mostly driven by investor interest in our products.