Shopify: Negative environment presents a buying opportunity

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As of this writing, Shopify (NYSE: SHOP) is down more than 65% from its all-time high. Blink and you missed it. It only took 3 months for the damage to occur.

SHOP stock chart
Data by YCharts

We live in what Tom Lee likes to call a treacherous market, and we are far from solving the big macroeconomic problems of the day. So the natural question with a high-risk asset like Shopify stock is how much further can it fall? Another Seeking Alpha contributor recently predicted another haircut in Shopify’s stock price, suggesting we’ll see stocks dropify below $400. This is based on a still high valuation multiple, as well as downward revisions to revenue and earnings estimates. I think the recent price drop reduces risk, increases potential future returns, and makes stocks more attractive than they have been for many years. While I am unable to make any predictions as to short-term price movements, I believe that the current negative environment surrounding “long-lived” assets presents a good buying opportunity in many growth stocks. , especially in Shopify.

Shopify Stock – There are short-term concerns

Shopify is a stock victim of its own success. It’s a classic “pandemic stock”, which has risen more than five times since the start of the pandemic, only to come back crashing. What worries shareholders right now is that while things are getting back to “normal”, we are seeing a slowdown in Shopify’s growth.

Shopify revenue growth

Shopify Q4 2021 Investor Presentation

You can clearly see the tailwinds COVID has provided the business in 2020 and 2021 in the chart above. And you can already see the deceleration into 2021. Shopify started 2021 with 110% year-over-year growth and ended it at 41%. Current revenue estimates for 2022 are between $5.7 billion and $6.5 billion, with a consensus estimate of $6.1 billion. This would translate to a growth range of between 27% and 41%. While I’m generally pretty confident in predicting that SaaS companies easily outperform analysts’ expectations, in the case of Shopify I’m not so sure, mainly because Shopify makes most of its money these days from non-recurring market solutions, but also because of existing headwinds and difficult comparables. .

Management itself hasn’t given any guidance on revenue since the COVID outbreak. However, they provided a caveat about their outlook for 2022 in their latest earnings release:

For 2022, we plan: Year-over-year revenue growth is expected to be lower in the first quarter of 2022 and higher in the fourth quarter of 2022 due to three factors. First, we do not expect the acceleration in e-commerce triggered by COVID in the first half of 2021 due to government lockdowns and stimulus measures to be repeated in the first half of 2022. ‘applications and themes cause two differences compared to the first of last year. quarter: the elimination of Shopify’s revenue share on the first $1 million of annual partner revenue, reset on January 1, and the move from recognizing gross revenue to recognizing net revenue for the sale of themes to following the revision of the contractual conditions with our thematic partners. Given that these conditions only came into play in the second half of last year, they will be a headwind for subscription solutions revenue in the first half of 2022, especially in the first quarter.

Add some caution about inflation and near-term consumer spending, and you have a pretty bleak picture for Shopify 2022, especially its first half.

Expanding the scope a bit beyond 2022 revenue growth, there are other important factors for investors: Shopify’s recent decision to double down on the Shopify Fulfillment Network was discussed at length at the last call for results. Management wants to operate more fulfillment centers itself, which should allow Shopify to deliver packages in 2 days or less to over 90% of the US population. This may sound exciting for traders, but investors are concerned about how it will affect profitability and cash flow in the short term (management has noted plans to reinvest all of its gross profit back into the business) , the longer-term margin profile, and whether Shopify goes beyond its core competency (execution risk!). Especially in a market that is looking for stability and profits, this decision – although potentially very beneficial for the company – is not welcomed by the market.

Additionally, somewhat less discussed by investors, Apple’s Mobile Advertising Changes (AAPL) are having an indirect, and most likely negative, impact on Shopify. During the third quarter 2021 earnings call, management noted that “Apple’s changes to the IDFA are harder to discern“. A quarter earlier they admitted that”it will reduce the effectiveness of some advertisements“, but added that he would also be further away”encourage merchants to seek new and multiple ways to connect with buyers in addition to increasingly expensive advertisements“. The main concern here is that reducing the effectiveness of merchant ads has a direct impact on Shopify’s GMV and, by extension, revenue and profit. Ben Thompson of Stratechery has written extensively on this issue and especially on Shopify’s reliance on Facebook (FB) in this regard, suggesting that Shopify may end up offering advertising services itself. In the meantime, these ad changes will pose challenges to Shopify’s business, creating magnified problems for investors, as it will be difficult to decipher how much of the revenue deceleration is coming from COVID normalization (which is absolutely fine) and if and how much is coming from the reduced effectiveness of Facebook ads (which would be a little more disturbing).

But Shopify’s business is still strong

I know many investors who would stop their analysis at this point, and I can’t blame them. A disadvantaged stock in a tough market, slowing growth, uncertain outlook, squeeze on margins, execution risk. Why would you want to be part of it?

The reason is simple: Shopify is a very high quality company that checks almost all the boxes I look for in a long-term investment; in terms of potential, there are few companies in the public markets that come close in my opinion. Let me highlight a few features of Shopify that make it a very attractive investment:

  • Secular growth tailwinds for entrepreneurship and e-commerce – Shopify should be able to increase revenue growth by 20-30% over the next decade.
  • A large and growing addressable market (estimated at $160 billion recently).
  • High optionality: Shopify has grown from just an e-commerce website provider to adding apps, POS, payments, more, shipping, multi-channel, capital, international expansion and now running. There are countless opportunities for Shopify to expand its platform.
  • Strong competitive advantages through high switching costs, network effects, brand and counter positioning.
  • Founder led by Tobi Lütke, nearly 10% insider ownership and a high Glassdoor rating.
  • A solid balance sheet with $7.77 billion in cash and $0.9 billion in debt
  • Medium to high gross margins at 54% and a highly scalable business model suggest high profitability going forward.
  • Strong past stock performance, significantly beating the market since IPO.

In the footsteps of Hamilton Helmer

Although I am confident in my own analytical abilities, it is always helpful to get confirmation from other respected investors. One such investor is Hamilton Helmer, business strategist, investor and author of the book 7 powers. At the end of 2021, his fund STRATEGY CAPITAL LLC held 25.75% of his portfolio in Shopify.

STRATEGY CAPITAL LLC Holdings as of December 31, 2021.

STRATEGY CAPITAL LLC Holdings as of December 31, 2021. (www.whalewisdom.com)

Strategy Capital has a concentrated long-only approach based on fundamental value and extended holding periods. One of their main goals is to identify companies with high “power”, that is, sustainable competitive advantages that generate excessive free cash flow. Helmer is a student of competitive advantages and probably one of the most knowledgeable people on the planet on this subject. The fact that Shopify is his most important position tells me that he strongly believes in the power of Shopify and potential future returns. The fund will disclose its updated positions from the end of Q1 2022 until mid-May 2022. I will be watching closely for any changes in Shopify’s position.

SHOP’s stock valuation has come down to earth

On top of that, Shopify is again trading its historical EV to generate multiple revenue:

Shopify EV to Revenue and Revenue
Data by YCharts

There’s no doubt that investors were overly bullish at over 50 times the sell-off, but now that stocks are down significantly, the stock looks quite attractive to me. Granted, its growth rate has also fallen (and will continue to fall in 2022), meaning that relative to its growth, stocks are still trading at historically high levels. However, I would also say that the stocks were undervalued for a while after the IPO, so referring to historical multiples can be a bit misleading. Below I have calculated a simplistic forecast, assuming average revenue growth of 30% for the next 5 years, dilution of 4% per year, and a net margin of 20% for the target PE (or hypothetical PE ).

Shopify revenue model

Author

My guess is that Shopify will be way off 20% net margins by 2026 as they will see plenty of opportunities for investment and growth. Shopify will also be far from done with its growth to $17 billion in revenue. I’m not saying that Shopify is trading at bargain prices (although, if it does, it’s probably in hindsight). The chart above simply illustrates that Shopify’s valuation isn’t out of this world and certainly doesn’t rule out above-market returns in the future.

I’m pretty happy with my position of around 5% in Shopify and I’m considering increasing my position to those levels. I acknowledge that the near-term outlook for the company is far from perfect and the current market environment could lead to further declines. But I also think the 65% price drop was overkill, given the company’s strong fundamentals. The next earnings report will come out at the end of April, which I expect will be generally disappointing in terms of growth and outlook. It will be interesting to see how the market reacts since expectations also seem quite low.

About Ricardo Schulte

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