Shopify Inc (US) (NYSE:SHOP) stock looks to have stabilized — at least for now. Shopify stock fell 16% last week after Citron Research questioned the company’s marketing techniques; SHOP stock, in total, has pulled back 21% from all-time highs reached last month.
As I wrote last week, I think Citron’s charges have some merit. But even if true, I’m skeptical they change the investment considerations around Shopify stock all that much. Shopify’s marketing likely will change, but if those tactics are limited to acquiring small and very small merchants, they should have little effect on revenue and profits over the long term.
The question, then, with SHOP back under $100 is whether last week’s decline creates a buying opportunity or if SHOP was overvalued to begin with. Citron argued the latter, with the firm pointing out SHOP’s premium on an enterprise-value-to-sales basis against even high-flying SaaS plays like Salesforce.com, Inc. (NYSE:CRM), Workday Inc (NASDAQ:WDAY) and Wix.com Ltd (NASDAQ:WIX).
But I liked SHOP stock after its second quarter earnings report, when the stock cleared $100. And I don’t see enough in last week’s news to change that opinion. SHOP is expensive, to be sure, but growth stocks usually are. And as investor attention turns back to that growth, Shopify stock should benefit.
The Importance of Growth to Shopify Stock
From a long-term standpoint, as long as Shopify keeps showing growth, SHOP stock likely has some upside. And growth has been impressive. Revenue increased 90% in 2016; it’s guided up another 66% in 2017, after 75% growth in Q2.
That growth should continue, even if it will decelerate over time. Shopify continues to increase its penetration overseas: 19% of merchants, per the Q2 conference call, are outside core markets in the U.S., Canada, Australia and the U.K.
Shopify now is shipping new point-of-sale readers, which will expand its reach offline and allow it to challenge Square Inc (NYSE:SQ), among others, in that space.
So, Shopify has two ways to continue its growth. The first is by getting more customers. International expansion will help in this regard. Shopify can acquire larger existing customers who might look to outsource sales and marketing functions to the platform. And there’s still a large base of small businesses looking to move online.
The second is by driving more revenue per customer. The Shopify “ecosystem” provides extremely high-margin revenue through operating an exchange for third-party developers. The move to in-store POS should help sales growth as well. Shopify offers financing to merchants based on credit card receipts, and more potential revenue drivers no doubt are on the way.
It’s a powerful combination — one that is overlooked, if not outright ignored, by the Citron short case. The only question is to what extent that growth potential is priced into Shopify stock.
What’s SHOP Stock Worth?
In its report, Citron cited Workday Inc as a potential cautionary tale for Shopify stock, at least from a valuation standpoint. As the firm pointed out, WDAY revenue has risen some 400% in four years — yet WDAY stock still trades modestly below early 2014 peaks.
With SHOP stock trading around 14 times revenue on an enterprise basis, even after last week’s declines, that is a real risk here as well. Shopify should turn profitable next year, at least on an adjusted basis, but it will take years before the profits are enough to support the current valuation.
That said, there’s still a path for those profits to push Shopify’s valuation above the current $10 billion or so. Revenue should clear $1 billion in 2019; operating leverage should begin to show up at some point as well. With approximately $1.5 billion in revenue and a 15-20% operating margin, net income could rise as high as $180-$200 million by 2021.
This, admittedly, still suggests a multiple of roughly 50 at this point. But other growth stocks like WDAY, SQ, and Veeva Systems Inc (NASDAQ:VEEV) have similar multiples already — with much slower growth. Over time, margins should rise above even that 15-20% range, as recurring revenues from already-acquired merchant customers are extremely cheap.
And simply from a qualitative standpoint, Shopify seems perfectly positioned. It’s dominant in its space. It’s offering is hugely important, easy to use, and still relatively cheap. This a company that is going to grow for years, with margins expanding all the while. And I still think that’s enough to drive Shopify stock higher — once investors are reminded of the growth.
As of this writing, Vince Martin has no positions in any securities mentioned.
