Shopify: Buy 'Anti-Amazon' After 80% Declines

Summary

• Shopify stock is down nearly 80% from all-time highs.
• The company has reported resilient fundamentals in spite of tough comparables and a tough macro backdrop.
• Profits have vanished this year but may return after the company completes its investment year.
• Even after the strong bounce from lows, the stock remains compelling here.
• Looking for a portfolio of ideas like this one? Members of Best Of Breed Growth Stocks get exclusive access to our subscriber-only portfolios. Learn More »

Morsa Images

Shopify (NYSE:SHOP) has bounced strongly from recent lows. Why did this happen, and is there more upside to be had? While the company has seen growth decelerate meaningfully in recent quarters, its results were arguably quite strong considering the tough pandemic comparables and weakening macro environment. It is possible that the stock was hit heavily due to an extreme shift in sentiment, as investors were spooked by the sudden disappearance of profits in what has become a "reinvestment year." But the fact remains that SHOP is as close as one will get to an "Anti-Amazon" e-commerce platform, a distinction which may help drive strong growth over the long term. In spite of the strong price action over the past weeks, SHOP remains one of my core positions.

SHOP Stock Price

SHOP has been crushed ever since the bursting of the tech bubble, falling so much that it is still trading around pre-pandemic prices.

Data by YCharts

I last covered SHOP in October where I explained why it was one of my largest positions. The stock has since returned 48% as the company has continued to deliver resilient fundamentals in spite of what on the surface looks like a business tied very closely to the pulse of the economy.

SHOP Stock Key Metrics

In its latest quarter, SHOP delivered 11% GMV growth, outpacing overall US retail growth of 9%. That growth was held back by foreign exchange headwinds by approximately 4%.

2022 Q3 Presentation

Revenue growth of 22% increased faster than GMV growth due to an increase in take rates - management noted on the conference call that the increase came from an increase in adoption of additional services like payments and capital, as well as Deliverr. Revenue growth saw 2% headwinds from currency fluctuations.

2022 Q3 Presentation

Gross profit growth lagged revenue growth due to the lower gross margin at Deliverr and merchant solutions revenue (this refers to the take rate earned on processed transactions). SHOP saw both operating income and net income turn negative year over year as expected, as 2022 has already been communicated to be a reinvestment year.

2022 Q3 Presentation

SHOP ended the quarter with $4.9 billion of cash, representing a sequential decline of $2 billion due to the closed acquisition of Deliverr. SHOP also had $2.4 billion of equity investments, giving it a strong balance sheet versus the $913 million in convertible notes. Those equity investments are primarily made up of its stakes in Affirm (AFRM) and Global-e (GLBE) - I expect some write downs on those investments in the upcoming earnings release as these stocks have been hit hard.

Looking ahead, management continues to guide for growth faster than overall e-commerce growth. Management also guided for operating expense growth to decline sequentially. In a market razor-focused on near term profits, that might not be everything that investors wanted to hear, but SHOP deserves high marks for being able to sustain impressive growth rates during a period in which many e-commerce operators are seeing stagnant growth.

Is SHOP Stock A Buy, Sell, or Hold?

The investment thesis for SHOP continues to center around its ability to be an "Anti-Amazon" enabler. SHOP has invested greatly in its fulfillment network, helping its merchants satisfy shipping orders within 2 days.

2022 Q3 Presentation

SHOP has also invested in cross-border commerce, making it possible for merchants to sell to over 150 countries.

2022 Q3 Presentation

SHOP is no longer just for small and medium sized businesses. Household brands - like Cole Haan in the latest quarter - continue to utilize its services as it has proven itself to be an effective and cheaper alternative to Amazon (AMZN). In the case of Cole Haan, they have adopted SHOP services for its entire business. Many other companies might first use SHOP for a portion of the business (like how Nike (NKE) uses SHOP for Converse Japan) and SHOP's strategy has been to steadily increase overall adoption as merchants feel comfortable with its platform.

Whereas the advancement in mobile technologies defined the last recession, SHOP management seems to agree with Alphabet (GOOG) (GOOGL) that artificial intelligence will be crucial in the next. In particular, SHOP has been utilizing artificial intelligence for fraud detection. Given the poor sentiment in the tech sector, it bears noting that the best tech company will continue to innovate even in the current tough market environment.

From a financial perspective, the long term thesis for SHOP centers around both its ability to take e-commerce market share and expand its take rates. As the Anti-Amazon, the market share piece is self-explanatory. SHOP earns around 2.4% on every transaction, far lower than the roughly 15% charged by AMZN. The discrepancy is somewhat explainable due to the efficient sales funnel of Amazon.com, but SHOP is also working on its own shopping website, one which may eventually lead to material take rate expansion.

Shopify

The stock is currently trading at 18x gross profits. The company is expected to sustain 20% top-line growth for many years.

Seeking Alpha

Based on a 60% long term net margin assumption based on gross profits and 1.5x price to earnings growth ratio, I could see SHOP justifying this 18x gross profits multiple. As growth accelerates, I would not be surprised to see further PEG expansion. SHOP offers strong upside from robust growth rates as well as multiple expansion potential.

The most visible catalysts may be a resurgence in growth rates as the company finishes lapping tough comparables as well as an improvement in profit margins. Regarding that last point, on the conference call management stated that "this is a company that likes to be profitable, and we will get back there," citing that the company has been profitable in 5 of the 7 years it has been a public company.

What are the key risks? The current macro backdrop may cause a delay in any projected recovery in growth rates. It is unclear how the stock would react in response to muted guidance for 2023. While I view the stock as being lower-risk similar to AMZN, its price action over the past year has made it at times look more similar with just any other tech stock. With SHOP still investing heavily back in its business, investors can not count on avenues such as share repurchases to reduce volatility. Another point is that it is possible for AMZN to continue increasing its dominance. I see SHOP continuing to gain market share as it helps bring more brick and mortar businesses online, but it is possible (albeit unlikely) that AMZN proves to be the "Death Star" and eventually owns the entirety of online retail. This threat may cause SHOP to continually invest in its fulfillment network which may pressure margins. Finally, due to the strong recent price action in the stock price, it is not as cheap as many tech peers and may see associated volatility if the relative premium dissipates. As discussed with subscribers to Best of Breed Growth Stocks, the best way to take advantage of the tech stock crash is by investing in a portfolio of undervalued tech stocks. SHOP continues to be one of the core positions in my portfolio.

Disclosure: I/we have a beneficial long position in the shares of SHOP, AFRM, AMZN, GOOGL, GLBE either through stock ownership, options, or other derivatives. 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.