After Earnings and a Big Selloff, Is Shopify Stock a Buy, a Sell, or Fairly Valued?

With expenses on the rise but its stock down 25%, here’s what we think of Shopify’s outlook.

Dan Romanoff, CPA 16 May, 2024 | 3:49PM
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The company logo hangs on the Ottawa headquarters of Canadian e-commerce company Shopify.

Shopify SHOP released its first-quarter earnings report on May 8. Here’s Morningstar’s take on Shopify’s earnings and the outlook for its stock.

Key Morningstar Metrics for Shopify

  • Fair Value Estimate: $93.00
  • Morningstar Rating: 3 stars
  • Morningstar Economic Moat Rating: Narrow
  • Morningstar Uncertainty Rating: Vey High

What We Thought of Shopify’s Q1 Earnings

  • Shopify reported good gross merchandise volume, raised pricing, and merchant additions driving revenue upside for the quarter. While profitability was good, operating expenses are growing, especially on the S&M line, which outpaced revenue growth. We were a little surprised to see this, since most companies are tightening up and delivering strong margins.
  • Subscriptions were considerably stronger than anticipated, while merchant solutions were slightly weaker. Strength in overall revenue was driven by continued merchant growth and performance, price increases, and the adoption of merchant solutions products like payments.
  • We still believe Shopify is well-positioned and has various irons in the fire to sustain durable growth.
  • The company only gives limited guidance, which exacerbates problems. In that vein, guidance was slightly light, but we see revenue performance as solid. First-quarter revenue grew 23% year over year as reported to $1.861 billion, ahead of our aggressive expectations.
  • The drop in share price of more than 20% since earnings seems like an overreaction, but the stock is back to being a touch below our fair value estimate of $93 per share, so there is some upside. However, we think investors can find similar upside in what we would consider higher-quality names like Adobe ADBE.

Fair Value Estimate for Shopify

With its 3-star rating, we believe Shopify’s stock is fairly valued compared with our long-term fair value estimate of $93 per share, which implies an enterprise value/sales multiple of 10 times 2024 revenue and a 1% free cash flow yield. Our forecast includes a continued shift to merchant solutions from subscriptions. We model an 18% compound annual growth rate for total revenue, driven by new merchants on the platform, Shopify Payments, Shopify Shipping, and Shopify Capital, as well as increasing gross merchandise value on the platform and international expansion. We believe the failure rate will remain high on the SMB side, but that successful merchants will become Shopify Plus enterprise customers. We estimate non-GAAP operating margin will expand from 11% in 2023 (actual) to the low 20% area in 2028.

Read more about Shopify’s fair value estimate.

Economic Moat Rating

We assign Shopify a narrow moat, primarily driven by switching costs alongside a network effect. Given the company’s history of generating excess returns, its complete portfolio of software and services, and its strong competitive position, we think Shopify will likely generate returns above its cost of capital over the next 10 years.

The more touch points a software vendor has across its organization and the more critical the function, the higher the switching costs. A great deal of time and expense is required to implement a new software package while maintaining the existing platform and retraining employees on a new system. Additionally, there is the operational risk of changing software vendors, including business process reengineering, loss of data during the changeover, and overall project execution. A major implementation likely involves a system integrator, and it can take over a year in bad cases. Lost productivity is more likely to be an issue as customers move up a learning curve on the new system, along with the distraction of users involved in the function where the change occurs.

Read more about Shopify’s economic moat rating.

Financial Strength

We believe Shopify is financially sound. Revenue is increasing rapidly, the company has reached an impressive scale, and the balance sheet is in great shape. We believe Shopify will continue to add new merchants at an impressive clip each year, attach rates for merchant solutions will remain high, and gross merchandise volume will continue to increase on the platform. The company is also moving upmarket from SMB to enterprise, which we expect to continue.

Read more about Shopify’s financial strength

Risk and Uncertainty

Shopify has a Very High Uncertainty Rating. The company generally trades at high multiples relative to peers. While the firm is expected to produce revenue growth at the high end of peers and the premium may be justified, higher absolute valuations offer less room for missteps and carry greater risks.

Shopify caters to SMB customers, which generates higher churn. Management does not disclose an overall retention figure, but we believe it is well below the more than 90% it has with Shopify Plus users. The failure rate for new businesses is very high—25%-75%, depending on the study and period. While there may be 47 million potential users in the target market, they generate low average revenue per user.

 

SHOP Bulls Say

  • Shopify’s growth has been and should remain strong, with robust new merchant adds, increasing GMV, and high attach rates.
  • We believe Shopify is attractive for SMBs because it is simple to use and has a wide variety of built-in features that make it a turnkey solution.
  • The company has many experts to help SMBs with website design, photography, and other elements, and it benefits from a large referral and developer ecosystem.


SHOP Bears Say

  • Shopify has traded at lofty valuations at times. While it might continue to generate strong growth, the company may fail to live up to optimistic assumptions embedded in the share price.
  • Shopify is overexposed to the economic cycle, with the high failure rate for core SMB customers exacerbated by the fact that retail volume would likely decline in a downturn. Additionally, management’s strategy is to avoid going direct to consumers.
  • The buildout of the Shopify Fulfillment Network will require substantial investment.

 

The author or authors do not own shares in any securities mentioned in this article.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Shopify Inc Registered Shs -A- Subord Vtg91.33 CAD-1.73Rating

About Author

Dan Romanoff, CPA  Dan Romanoff, CPA, is an equity research analyst on the technology, media, and telecommunications team for Morningstar.

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