The e-commerce landscape is dominated by behemoths like Amazon and Walmart. However, there are a number of rising players that have made inroads. One of them is Shopify (SHOP 1.41%). If you have ever clicked on an advertisement on Facebook or Instagram and subsequently made a purchase, chances are you've checked out using Shopify.
During the COVID-19 pandemic, Shopify boomed in popularity. It's no secret that the pandemic was a catalyst for online shopping and the creation of side hustles (monetizing a hobby). During this period, Shopify's offering was in high demand, and subsequently, the financial profile of the company seemingly changed overnight.
It should be noted that Shopify's infrastructure is designed for businesses of all sizes, and not just small or medium businesses (SMBs). For example, Tesla uses Shopify as does PepsiCo, LVMH Moet Hennessy Louis Vuitton, and Nestle.
Furthermore, large consulting firms like Deloitte and enterprises such as IBM have strategic agreements with the e-commerce company as systems integrated partners.
Like many other businesses, Shopify's operating results have started to normalize in a post-pandemic world and shares are up roughly 70% this year as of the time of this article, although they still are down about 65% from all-time highs in November 2021. Let's dig into the company's first-quarter results and assess if it's trading at a reasonable valuation and deserves a look for your portfolio.
Shopify's Q1 at a glance
During Shopify's fourth-quarter 2022 earnings call, management offered the following outlook for the first quarter of 2023:
- Revenue growth in the high-teen percentages year over year;
- Gross margins to be slightly higher quarter over quarter.
Per the company's Q1 earnings release, Shopify's revenue grew by 25% (and 27% on a constant-currency basis) to $1.5 billion. And its gross margin was 47.5%, up from 46% in Q4.So it's safe to say that Shopify exceeded its own forecast.
Another metric to analyze is the company's operating expenses. For the quarter, Shopify's operating expenses totaled $910 million, up 24% year over year. That increase was mainly driven by salaries and wages, including those of the company's Deliverr employees, a business that Shopify is now selling just a year after buying it.
While Shopify blew away its revenue forecast, investors should be keenly aware that the company's combined annual growth for cost of goods sold and operating expenses outweighed its revenue growth. For this reason, Shopify reported an operating loss of $193 million, nearly double its operating loss in Q1 2022. Yet despite these operating losses, Shopify reported net income of $68 million, or $0.05 in earnings per share (EPS).
By contrast, Shopify reported a net loss of $1.5 billion ($1.17 EPS) for Q1 2022. This was due to a $1.6 billion net unrealized loss on equity and other investments.
Shopify owns stakes in other companies, and when these stocks experience volatility in either direction, it must factor those unrealized gains or losses relative to the cost basis for each investment into its bottom line. It should be noted that in Q1 2023, Shopify booked a net unrealized gain of $269 million, more than enough to overcome the operating loss.
Overall, these financial results look like a mixed bag to me. I am quite impressed by the revenue growth. However, Q1 clearly illustrated that the Deliverr integration, and its associated costs, were a drag on the core business. After a year of rising costs and slow integration efforts, it's no wonder Shopify decided to pull the plug and divest these logistics assets to Flexport. While Shopify is also undergoing cost reductions in the form of layoffs, I question if a consistent path to profitability is viable.
Image Source: Getty Images
Didn't see this coming
Although Shopify beat Wall Street's expectations, I think the real cause of its post-earnings stock surge was the surprise announcement that the company is selling its logistics assets to Flexport, a leader in that niche.
Remember, it was only last May that Shopify acquired logistics and fulfillment company Deliverr. The thesis behind the deal was to layer Deliverr's merchant solutions on top of Shopify's fulfillment network (SFN) infrastructure. But over the last year, management has been updating investors about its integration efforts. Namely, Shopify's management made it clear that the extra costs associated with building out SFN will have a dilutive impact on the company's margin profile.
While it may be uncomfortable to admit, Shopify's Q1 results show that it has overhead bloat, driven mainly by added headcount from Deliverr. The divestiture helps Shopify cut labor other non-core operating expenses related to its logistics business.
Is the stock a buy?
In my opinion, there is more than meets the eye here. When it comes to logistics, Amazon is a juggernaut and it took decades to get there. Plain and simple, Shopify does not have the financial flexibility or the technical know-how to compete. On the surface, selling the logistics assets seems like a smart and responsible move for Shopify.
After the earnings call, analysts at several Wall Street institutions, among them Goldman Sachs, Citigroup, Morgan Stanley, and Piper Sandler, revised their price targets for Shopify.
Citigroup is the most bullish with a price estimate of $65 per share, implying roughly 8% upside from a recent price of about $60. By contrast, Piper Sandler modeled an intrinsic value of $50 per share, or 17% downside. Goldman and Morgan Stanley have price estimates of $59 and $54 per share, respectively. The common theme among the banks is that all have neutral or neutral-equivalent ratings.
Shopify is not yet consistently profitable, which makes traditional valuation metrics such as price-to-earnings or the price/earnings-to-growth ratio less useful. One metric that can help is price-to-sales (P/S). Shopify is currently trading at 13 times its trailing-12-month revenue. P/S ratios vary by industry. But a general rule of thumb is to compare P/S ratios among competitors in the same industry. Given that comparable companies such as Amazon and Walmart are much larger, mature businesses, it's not necessarily fair to judge Shopify's P/S ratio because it's still a growth company, which as a group tend to have high ratios.
I personally do not like stocks when momentum is pushing it up. As a long-term investor, I am not looking to buy on perceived good news and sell on an upswing to book a quick gain. The most prudent action for investors is likely to assess Q2 earnings and digest how the Flexport deal is going. While Shopify has built a credible operation, the company faces an uphill battle, particularly with Amazon. There is definitely money to be made in Shopify stock, but its volatility and underlying business fundamentals are enough for me to look elsewhere, and based on the available metrics it's doesn't seem to be trading at a reasonable level.
