Shopify’s (NYSE:SHOP) first-quarter results indicated that the company could have significant problems looming. Meanwhile, the valuation of Shopify stock remains way too high, given its declining profitability and meaningful competition.
There was a great deal to like about the company’s Q1 results, as its total revenue soared 47% year-over-year and its results came in well above analysts’ average outlook.
But a few unfavorable trends appear to be developing. First, Shopify, on its first-quarter earnings conference call, noted that “March and April … saw more merchants downgrade from Shopify Plus to lower-priced plans than in January and February.” The company added that it had experienced “an uptick of subscription cancellations,” while fewer overseas businesses joined its platform than in the same period a year earlier.
That information suggests that a meaningful number of the company’s core small and medium business clients are, in spite of the sales they’re generating on Shopify, experiencing significant financial difficulties.
As the economic downturn continues and more small and medium businesses go bankrupt, the number of merchants leaving Shopify Plus and those abandoning Shopify altogether are bound to accelerate.
It’s easy to see how the process could unfold. Specifically, before the coronavirus crisis, many small business owners likely owned brick-and-mortar stores and sold products on Shopify. Due to the lockdowns, they will lose their stores and all of their funds.
As a result, they will have to get jobs and will no longer have the time and money to buy products, pay Shopify’s fees, or run their businesses on Shopify. In my opinion, the increase in the number of merchants who left Shopify Plus in Q1 will prove to be the tip of a pretty big iceberg.
Another problematic statistic was the company’s statement during the conference call that “the number of consumers making a purchase for the first time from any Shopify merchant grew 8% between March 13 and April 24 compared with the previous 6 weeks.”
At a time when people were staying home more than ever and the use of so many digital products was booming, an 8% acceleration of new user growth sounds very tiny to me. In fact, the statistic makes me think that the company’s merchants are losing significant market share to larger e-commerce players like Walmart (NYSE:WMT), Target (NYSE:TGT), eBay (NASDAQ:EBAY) and, of course, Amazon (NASDAQ:AMZN).
Meanwhile, Shopify reported an operating loss of $73.2 million, over double its operating loss of $35.8 million during the same period a year earlier. The company explained that it had spent more money on marketing, while its integration of 6 River Systems, the fulfillment firm it acquired, is also costing money.
Further, it increased its “allowance for potential losses related to Shopify Payments and Shopify Capital due to the potential impact of COVID-19.”
Its decision to increase the amount it loans businesses by 85% year-over-year to $162.4 million through Shopify Capital in the midst of all the difficult problems small business are facing is problematic and is likely to hurt Shopify and its stock down the road.
Valuation and the Bottom Line on Shopify Stock
But the bigger-picture issue is the fact that Shopify’s business isn’t very close to being profitable even though its stock’s valuation is stratospheric.
Specifically, its shares’ price-sales ratio is 50. That’s an extremely high valuation. And according to a Seeking Alpha columnist who was once very bullish on Shopify stock, the company’s “virtual PEG,” which compares the stock’s valuation relative to the company’s profit outlook and growth, is now over 4.
In November 2018, its “virtual PEG” was 1, he reported. He believes that SHOP stock “is worth between $275 and $350 and that’s with very optimistic numbers.”
Finally, Shopify has very tough competition in the e-commerce sector that could prevent it from growing as much as expected over the long term. EBAY and AMZN, for example, could both find ways to make their platforms more attractive to small businesses and take market share from Shopify. Or Walmart could take share from Shopify’s clients.
Given all these points, I continue to recommend that long-term investors sell SHOP stock.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Lyft, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any shares of the aforementioned companies.