Markets were not impressed when Shopify (NYSE:SHOP) reported third quarter 2019 results on Oct. 29. Without doubt, there are positives in Q3 results. Revenue growth was robust at 45%, monthly recurring revenue continues to trend higher and gross merchandise volumes also swelled. However, SHOP stock seems to have moved way ahead of fundamentals.
I believe that the shares will trend lower in the near-term. Shopify stock is a typical case of good business, but a bad investment. At least for the near-term.
Shopify’s idea to boost its warehousing network in the United States might be a good idea. However, it’s an expensive competition with Amazon (NASDAQ:AMZN). SHOP plans to spend $1 billion over the next five years for a robust warehouse network.
The company also believes that “incremental revenue will largely offset costs” and that “bulk of net return is expected beyond 2023.”
The bottom-line: SHOP stock, with a market capitalization of $36.5 billion is unlikely to report healthy operating level profits in the next three to four years.
For 2019, SHOP expects GAAP operating loss in the range of $155 million to $168 million. In addition, operating cash flows will remain muted and free cash flow is likely to remain negative. Negative free cash flows would, in turn, imply potential leveraging or further dilution of equity.
This is not worrying for a high growth company and Shopify does have ample metrics to demonstrate steady growth. However, can valuations sustain at current levels? I certainly believe that the stock needs to cool-off.
I want to add here that the company seems fully financed for medium-term investments with $2.67 billion of cash & equivalents. That’s certainly a positive, but does not justify a forward PE of 526x.
Several Positives Beyond the Cash Burn Perspective
My idea was to highlight the cash burn outlook for the next few years purely considering the pricey valuations. SHOP has been delivering healthy top-line numbers and has a robust growth model.
The company’s market share growth among e-commerce platform providers is the first positive. E-c0mmerce app maker WooCommerce currently has a market share of 26% and SHOP is second with a market share of 20%. As Pagely notes, the third most popular e-commerce platform is Magento, which has lost market share to the top two in the recent years.
I believe that e-commerce platforms will increasingly move towards “winners take it all” and SHOP is well positioned to increase market share.
In particular, the company is looking beyond the U.S. to sustain revenue growth. With Shopify Admin already available in 19 native languages, the company is likely to make global market inroads.
As Amy Shapero, Shopify’s CFO noted, “Our strong results in the quarter were driven in part by the success of our international expansion.”
Therefore, I would not be surprised if top-line growth remains well over 25% even on a three-to-five year horizon. This will keep the markets interested, but valuations need to adjust on the downside considering the cash flow outlook.
My view on robust top-line growth in the long-term is backed by the following fact — SHOP reported one million merchants on Shopify as of Q3 19. It is estimated that the number of online stores globally is at 24 million. Therefore, there is a big market to tap and SHOP is well positioned to grow.
Concluding Thoughts on SHOP Stock
SHOP stock is certainly worth considering for the long-term. However, I don’t see the shares as a compelling investment at a forward PE of 526x.
On the business front, I see steady growth in monthly recurring revenues as a big positive. As an increasing number of clients mature, it will translate into robust revenue per client and cash flow upside.
Increasing contribution of Shopify Plus to monthly recurring revenues is another big positive. Shopify Plus is intended for high volume merchants and growth in MRR indicates big brands preferring the platform.
Overall, Shopify has a robust business model with global growth visibility. I am bullish on the business, but bearish on Shopify stock for the near-term.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
