Buy Shopify Stock on This Dip Given Huge Growth Expectations

Shopify (NYSE:SHOP) stock is down 22% off of its Q1 2020 highs but is still up 24.3% for the year so far. That is pretty rare for stocks these days.

Doing All the Right Things Isn't Enough to Keep Driving Shopify Stock

Source: Beyond The Scene /

Moreover, it looks like this dip is just temporary. For example, Shopify stock was up 5.7% Friday, Feb. 28, when most stocks were down.

Investors should consider taking advantage of this opportunity. In fact, it looks like revenue and earnings will do well during any downturn resulting from the coronavirus outbreak. The most fundamental reason for this is that people will be more likely to buy goods online on sites like Shopify’s.

Revenue and Earnings Upward Surprise in Q4

A major reason why Shopify stock has done so well recently is its latest earnings report. Shopify’s fourth-quarter revenues grew 47% to $505.2 million, significantly ahead of the market’s forecast of $482.5 million.

Moreover, net income was positive for the first time at $771,000, or one cent per share. This compares with a net loss of $1.5 million, or one cent per share a year ago. On an adjusted basis, EPS was 43 cents, which was also significantly ahead of the Street’s estimate of 23 cents.

Shopify also had a very positive outlook for both 2020 and Q1 2020. It expects revenues for the year to be up 36% at the midpoint of its guidance.

However, this guidance from Shopify was on Feb. 12, well before the recent coronavirus outbreak. That is why Shopify stock took a hit from its highs.

Concerns Remain Over Shopify’s High Valuation

At today’s price Shopify stock has a market value of $54 billion. This is a stratospheric 34 times its last 12 months revenue of $1.578 billion for 2019. Moreover, it is also 25 times the expected midpoint range of $2.15 billion for Q1 2020.

So there is no room here in that valuation for any performance issues. And the coronavirus could clearly dish up some difficulties for Shopify.

Moreover, a recent article in Seeking Alpha points out that Shopify stock trades at a premium to public SaaS companies.

For example, Workday (NASDAQ:WDAY) trades at an EV/Sales ratio of 11.6 times for the trailing 12 months. Paycom Software (NYSE:PAYC) is at 22.5 times sales and ServiceNow (NYSE:NOW) is at 17.9x. These are lower than Shopify’s 33 times EV-to-Sales ratio for the last 12 months.

Other Issues Facing Shopify’s Merchants

Shopify makes two general types of revenue. It provides an eCommerce software solution for merchants. About 36% of its sales come from subscriptions from merchants who set up their online stores on Shopify.

But 64% of revenue comes from taking a fee derived from Gross Merchandise Volume (GMV). In other words, they get a cut out of every sale.

The problem here is that many merchants order their goods from China and the Far East and then sell them on Shopify. Their access to goods recently has been disrupted by the general shutdown in China.

For example, CNBC recently reported that Amazon’s third-party sellers are struggling to keep their inventory in stock as a result of the general China economic shutdown. The point is that many of these sellers are also Shopify merchants. In any case, Shopify merchants will be having the same issues.

The point is that Shopify’s GMV is likely to take a hit during Q1 2020, and potentially longer. It will depend on how long it takes China to get up and running, so to speak.

This may lead some Shopify merchants to find other suppliers, or possibly even set up their own selling sites. Both of these will lead to lower revenues for Shopify in the long run.

What Is Shopify Doing to Address Concerns?

Shopify is addressing some major issues that face its online merchants. For one, the company has started the Shopify Fulfillment Network that will compete directly with the Amazon Fulfillment Network, run by Amazon (NASDAQ:AMZN). It will allow Shopify to order inventory from multiple sources and store them at Shopify warehouses.

This will dramatically reduce the shipping times for Shopify merchants. For example, the typical Shopify merchant works on a drop-shipment method to source its inventory from China and other Far East suppliers. Right now that is what is causing the delays in shipments.

With the Shopify Fulfillment Network, the merchant can pre-order inventory, have it shipped to Shopify’s warehouses, then have the order sent out to customers much faster.

Shopify indicated in its latest release that it is scaling up the Shopify Fulfillment Network. It purchased 6 River Systems last year to develop robotic warehouses just like at Amazon.

As a result, Shopify merchants, many of whom also use Amazon Fulfillment Network, will likely have lower costs and more choice on how to source and fulfill their orders and shipments.

What to Do with Shopify Stock?

Shopify stock is at a temporary low that is not likely to last, given the huge growth it is expected to have over the next year. Some analysts believe that Shopify is growing so fast that its valuation is not that high given the growth curve.

Moreover, once Shopify’s huge capital expenditures are over with its Shopify Fulfillment Network, free cash flow and profits are likely to spike. This is exactly what happened at its rival Amazon.

Don’t be confused. Shopify stock is not a value stock. There is not much of a margin of safety. It is a classic momentum stock, but so was Amazon stock during most of its massive rise. In effect, the idea is that Shopify will grow into its valuation. If you believe that, you might want to take another look at Shopify stock while it is trading at these levels.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review hereThe Guide focuses on high total yield value stocks. Subscribers a two-week free trial.

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