There is little doubt that Shopify (NYSE:SHOP) has an attractive business model, and the company has delivered in terms of registering healthy growth. Furthermore, there are multiple revenue upside triggers in the coming years for Shopify. So it is not surprising that Shopify stock has surged by 165% in the past year and currently trades at nearly $490. However, I believe that a correction is imminent before the next leg of rally.
If we look at the median of 28 analysts providing a price forecast for Shopify stock, it’s currently at $587.50. This implies a potential upside of 20% over a 12-month horizon. Clearly, the juice in the rally has been absorbed, and this backs my view that profit booking is advisable.
Additionally, I would also like to bring investor attention to one fact: For fiscal year 2016, the company reported revenue growth of 90% on a year-on-year basis. However, revenue growth decelerated to 73% in FY2017, 59% in FY2018 and to 47% in FY2019. Furthermore, based on the mid-point of FY2020 revenue guidance, growth is likely to be 36% as compared to FY2019.
Collectively, it is evident that growth momentum is slowing. This is understandable as the revenue base increases. However, it is important to note that Shopify has a market capitalization of nearly $57 billion and the company is likely to remain at an operating level loss. For FY2020, the company expects GAAP operating loss of between $324 million and $344 million.
I am not suggesting that profitability is not coming, though. In few years, Shopify will transform into a cash flow machine. My only point now is that the stock might have run ahead of fundamentals.
Existing Merchants Can Fuel Cash Flow Growth
In terms of subscription plans, Shopify has a basic plan starting at $29 per month that targets entrepreneurs. For small and medium size businesses, the monthly plan ranges from $79 to $299. Also, Shopify Plus is for large businesses and has a charge of $2000 per month.
So, the objective of telling this is as follows. In 2019, merchants selling on Shopify grew their Gross Merchandise Volume (GMV) year-over-year at an average monthly rate of 21%. Additionally, merchants on the Shopify platform that achieved over $1 million in GMV grew by 44%.
As existing merchants grow in size, the natural course of action is to upgrade the subscription plan. So with Shopify now powering over one million merchants, there will be steady upgrade to higher cost monthly plans as the business grows. Therefore, monthly recurring revenue will continue to trend higher.
It is also worth noting that Monthly Recurring Revenue (MRR) as of December 2019 was $53.9 million, which was 32% higher as compared to December 2018. I expect MRR growth to sustain with increasingly higher contribution coming from Shopify Plus.
From a profitability perspective, I want to add here that selling and marketing expense as a percentage of revenue was 34% in FY2015. This has declined to 28% in FY2019. As brand visibility increases, selling and marketing expense will continue to trend lower.
Global Growth Opportunities
Shopify’s top-line growth has decelerated on a relative basis. But, I do believe that healthy growth will sustain in the next five years.
The first reason is top-line growth from existing merchants. The big advantage here is that it does not require an additional advertising and selling expense.
Additionally, the second reason is global expansion. This will keep the company’s expenses high, but addition of merchants is likely to offset the cost of merchant acquisition.
It is worth noting that in FY2019, Shopify added 13 additional native language capabilities on the platform. And now, the platform supports a total of 20 languages. Moreover, selling in multiple currencies has also helped in merchants expanding their business globally.
Shopify is also building a team in China, which will look at partnerships and growth acceleration in a high-potential country.
My Final Thoughts on Shopify Stock
Shopify certainly has an attractive and scalable business model. Once Shopify brand awareness increases globally, the company’s expenses will decline and cash flow will swell.
So with all these positives, Shopify stock is worth considering for the long-term portfolio. However, I would remain cautious considering the fact that the stock has jumped by 165% in the past year
Overall, a correction would be healthy and provide a good entry opportunity.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
