Summary
Shopify stock has been on a tear this year, rising more than 78%, beating all major stock market indexes handsomely.
As revealed in this analysis, there are many reasons behind Shopify's stellar stock market run this year.
Some of the favorable developments that have helped Shopify this year will continue to have a positive impact in the foreseeable future.
Commerce Components by Shopify will play an important role in Shopify's next growth phase but the company might have to improve its data analytical capabilities.
There are early signs of long-lasting competitive advantages.
Sean Gallup
Shopify Inc. $Shopify(SHOP)$ stock has been on a tear this year, rising more than 78%, beating all major stock market indexes handsomely. It was hard to be a tech investor last year, but it has been equally rewarding to be one this year. SHOP stock’s stellar run this year has been fueled by several favorable developments (discussed in the next segment), and these positive trends are likely to continue in the foreseeable future, enabling Shopify stock to move higher from here. As I discussed in my previous article in February, Shopify has a lot going in favor of the company but I continue to be wary of its valuation although I acknowledge Shopify deserves to trade at premium valuation multiples at a time when the company is carving out competitive advantages.
Why Has Shopify’s Stock Price Gone Up This Year?
Shopify stock has benefited from not just one but many favorable developments this year. The rising expectations for a less aggressive Fed in the second half of this year was one of the primary triggers of the rally earlier this year. Expectations for a less aggressive Fed are stemming from projections for cooling inflation amid notable improvements in the global supply chain. As illustrated below, the Fed dot plot released in March points to just one rate hike this year.
Exhibit 1: The Federal Reserve’s updated dot-plot
Federal Reserve
Rising interest rates can have a major impact on growth companies as the majority of their cash flows are expected in the future, which would have to be discounted at a higher rate to find their present value amid rising rates. On the contrary, declining interest rates lead to an increase in the present value of expected future cash flows. Shopify, as a growth machine, felt the wrath of rising rates in 2022, but the possibility of a reversal of this trend has sent SHOP stock higher this year.
Shopify stock rallied last month with the company posting better-than-expected earnings and revenue for the first quarter of 2023. The company guided for strong revenue growth of 25% in the second quarter as well, which boosted investor confidence.
In the last few quarters, job cuts have had a more significant impact on stock prices than earnings, and Shopify joined the long list of tech companies to lay off employees in May with the announcement that 20% of its workforce will be reduced along with the decision to sell its logistics business. This announcement boosted Shopify stock as this came at a time when investors were concerned about the company’s cost structure.
Shopify’s strategy pivot to prioritize the core business of the company has also been rewarded this year. After spending billions of dollars to build logistic capacity, Shopify announced in May that it is selling the logistics business to Flexport, including Deliverr which was acquired just last year for $2.1 billion. The sale was completed yesterday. The company also announced the sale of 6 River Systems, the robot fulfillment solutions provider, to Ocado Group last month. These asset sales are expected to lead to a leaner business that is capable of achieving cost efficiencies in the coming years.
The improving sentiment among Wall Street analysts has been another driver of SHOP stock this year. In April, JMP Securities upgraded Shopify based on the improving cost structure of the company and website traffic data. This followed an earlier rating upgrade by DA Davidson.
Shopify’s venture into AI was another confidence booster that drove stock prices higher. Since the launch of ChatGPT late last year, there has been an increased enthusiasm toward AI. Shopify announced integration with Google AI last March to offer Discovery AI solutions to its merchants.
What Is Shopify’s Long-Term Outlook?
Shopify, until recently, followed a strategy that prioritized growth. This year, however, the company has pivoted to focus more on profits. The company spent billions of dollars over the last couple of years on its logistics business, which is now being divested. This decision is likely to have a positive impact on Shopify’s profit margins in the long run. In Q1, the gross margin of the company declined to 47.5% from 53% a year ago, primarily because of the dilutive impact of Deliverr. With Deliverr being divested, Shopify has eliminated a major barrier to margin expansion.
Shopify’s operating margins will come under pressure in the coming quarters as the Shopify Payments segment, which is a lower-margin business, continues to grow at a faster pace than the core subscription business. However, the growth in Shopify Payments is a net positive for the long-term financial performance of the company as it enables Shopify to keep its customers within its ecosystem throughout the entire life cycle of a product sale. For Shopify, there is nothing more valuable than building a sticky customer base, and Shopify Payments will help the company achieve this objective.
Looking at the long term, Shopify’s prospects are tied to its ability to attract and retain large enterprises that conduct business globally. To make progress from this end, the company launched Commerce Components by Shopify – or CCS - earlier this year. Commerce Components is a suite of products that allows users to integrate 30+ modular components and compose a commerce stack that fits the business. These components can be modified to fit the needs of different merchants. Commerce Components is a product that comes with flexible APIs, which is essential for large retailers to build personalized customer experiences. With developers being able to use any front-end framework of their choice, Commerce Components differs from Shopify Plus as the latter offers an all-in-one solution rather than a customizable solution.
CCS, however, will have to compete with well-established giants in this space such as Salesforce, Inc. $Salesforce.com(CRM)$ and even Adobe Inc. $Adobe(ADBE)$ in some instances. Therefore, Shopify will have to offer more flexibility in terms of data analytical integrations to attract large enterprises. These large enterprises often use server-side event data to use in their marketing campaigns as their objective is not just to understand customer purchasing habits, but also the entire customer journey, which gives them the opportunity to cross-sell and upsell products in the future. This is an area where CCS might underperform in comparison to more established giants.
With the company’s next growth leg tied to attracting and retaining large enterprises, I am closely monitoring the data analytical tools introduced by Shopify as I believe these tools will play a key role in the growth of this business segment. For now, I believe Shopify has made steady progress by unveiling a suite of products and dozens of high-performing components to attract large retailers.
Exhibit 2: Recent customer wins
Earnings presentation
As an established leader among SMBs with a digital-first approach and an emerging leader among large enterprises, Shopify is well-positioned to benefit from the increasing penetration of the e-commerce sector. As recently as 2015, e-commerce sales accounted for just 7.4% of total retail sales but in 2022, almost 20% of total retail sales are estimated to have come from digital channels. This number is expected to move higher in the coming years.
Exhibit 3: E-commerce sales as a percentage of total retail sales
Statista
In the long run, I expect Shopify to enjoy an expansion in profit margins as the company scales further, aided by the continued onboarding of large-scale businesses. The company has a long runway for growth.
Positive Earnings Revision Trends Will Boost The Stock Price
At Beat Billions, we believe positive earnings revisions will have a meaningful impact on stock prices. After falling off a cliff in 2022, earnings expectations for Shopify have trended in the right direction this year. SHOP stock has already reacted to this notable improvement in Wall Street earnings expectations.
Exhibit 4: EPS revision trends
Seeking Alpha
Aided by the early success of Commerce Components, the expected margin improvements resulting from asset sales and job cuts, and the strong momentum behind e-commerce sales even at a time when recession risks are looming on the horizon, I believe earnings expectations for the next fiscal year will continue to move higher from here, paving the way for higher stock prices.
Takeaway
I remain wary of Shopify’s valuation but in the foreseeable future, I believe SHOP will continue to have much-needed earnings momentum, which will push the stock price higher. Because Shopify is a company that has already carved out competitive advantages in a highly competitive niche, I believe the company is on the right track to enjoying consistent economic profits in the long run. The path to profitability is becoming clearer by the day, which alleviates some of the previous concerns I had about the company’s future. Although I might not pull the trigger to invest in Shopify today, I believe investors should feel comfortable holding SHOP until the investment thesis fully plays out.
Source: Seeking Alpha
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