Once a darling of the stock market, Shopify (NYSE: SHOP) stocks have fallen more than 70% in 2022 as investors continue to punish highly-rated tech companies and e-commerce growth has slowed rapidly after its boom in 2020-2021. I’ve read numerous articles, reports, and Twitter threads confidently stating that Shopify’s growth story is well and truly over – but I think it’s time to take a step back.
Shopify is a leading provider of e-commerce infrastructure, giving customers the tools to help them start, grow, market, and manage a retail business of any size. The company’s platform started out as a simple solution to help small and medium-sized businesses build an e-commerce presence, but it has continually added more products and features to its platform, resulting in impressive growth over the past decade.
Its business model revolves around two sources of revenue: subscription solutions and merchant solutions. Subscription solutions are recurring revenue generated primarily from the sale of subscriptions to the Shopify platform; Simply put, it’s recurring revenue that customers pay to build their eCommerce website on Shopify. Merchant solutions are mostly performance-based – I’m a big fan of them; this means that when Shopify customers succeed, then Shopify succeeds, thus aligning the incentives. Most of this revenue is related to Shopify Payments payment processing and currency conversion fees, although additional revenue is generated by Shopify’s wide range of other offerings, including Shopify Capital, Shop Pay Facilities, Shopify Fulfillment Network, etc This hybrid business model has given Shopify a solid foundation of high-margin recurring revenue from its subscription solutions combined with the highly scalable, performance-based revenue of its merchant solution.
It was Shopify’s continued ability to grow rapidly and expand its offerings that first drew me to the company, but there have undoubtedly been some headwinds in recent months.
short term pain
Those who preach Shopify’s demise certainly have the numbers to make their case. As a company historically valued for its rapid growth, investors were spooked when management gave the following (rather open-ended) advice in their Q4’21 results:
Given these broader secular and economic assumptions, our financial outlook calls for full-year 2022 revenue growth to be less than the 57% revenue growth achieved in 2021, but still rapid and greater than the growth of the e-commerce, driven by our many growth drivers, including expanding our services to more merchants in more geographies, the growing contribution of newly added products, and our strong value proposition for multi-channel commerce that offers independent brands of all sizes a way to build a strong, frictionless presence across the Internet, in apps and in person.
Obviously, “we expect revenue growth of less than 57% year-over-year” is pretty vague, and we’re in a market that doesn’t like uncertainty too much. Yet the other part to point out is management’s reference to “outpacing e-commerce growth”, and judging by Q1 22 trends, Shopify continues to do so – despite being one fastest growing e-commerce companies over the past 5 years while significantly larger than many competitors, Shopify’s revenue growth rates still outpace those of Wix.com (WIX), Squarespace (SQSP ) and Amazon (AMZN).
Earlier I mentioned the prospect, and that’s it – e-commerce has seen a boom in 2020 and further normalization in 2021, with the economy benefiting from substantial support and stimulus from the government and the central bank – that is undeniable. But in 2022, the world is fully opening up again and inflation is HOT. Understandably, governments and central banks around the world are doing what they can to get inflation under control, mostly in the form of substantial interest rate hikes, which has had the intended effect of depressing demand. So we are now comparing an economically difficult 2022 to a booming 2020 and a strong 2021.
If my investment time horizon was, say, 6 months, I could understand avoiding Shopify. But my horizon is years, even decades, and that changes things radically. I won’t pretend to know when this short-term global economic pain will subside, but I do know that Shopify is a company that has always served its shareholders, with management that I trust and a business model that is built for the hit.
So if like me you believe that Shopify will continue to be a leader in its field, and like me you have a time horizon longer than a baseball season, how much does this 70% drop in the price of the is the action attractive?
As with all high-growth, innovative and disruptive companies, valuation is difficult. I believe my approach will give me an idea of whether Shopify is incredibly overvalued or undervalued, but valuation is the last thing I look at – far more important is the quality of the company itself.
Uncertain broader economic conditions make forecasts uncertain, and I’ve conservatively assumed a substantial slowdown in expected revenue for Shopify. This starts with just 25% year-over-year growth in 2022, followed by 20% growth in 2023 (assuming a slow macroeconomic recovery), with revenue growth then accelerating to 30% by 2026. I could definitely see Shopify exceeding those expectations as it rolls out. more solutions to more geographies, but I prefer to err on the side of caution.
We can expect Shopify’s level of capital expenditure to increase over the next few years as it grows its delivery fulfillment network, however, this should result in long-term shareholder benefits as the being able to offer one or two day delivery through Shopify is likely to be another “merchant solution” that will increase revenue. This will impact free cash flow generation in the short to medium term, but I assumed a slowdown by the years 2025 and 2026.
Similarly, I expect cash from Shopify’s operations to become much lower as a percentage of revenue in 2022, as 2021 was a rather exceptional year where Shopify (almost accidentally) generated a substantial amount of cash. This will normalize, but over time I expect a more gradual increase in cash generation as Shopify continues to benefit from scale.
Finally, we’re moving towards the EV/FCF multiple, and that’s always a tough one for a business like Shopify, where the current model isn’t about maximizing free cash flow, but rather about growing and reinvesting in order to capture substantial market. opportunity before them. I assumed a wide range of multiples of 2026, from 32.8x to 131.2x, because it is unclear what type of market we will be in. Still, I think my midrange assumption of 59x is reasonable, particularly if Shopify continues to grow revenue in the 20% to 30% range from 2026 and the FCF margin increases. I also assumed a 5% increase in outstanding shares each year, as Shopify has a history of diluting shareholders (although that has slowed down lately).
Put it all together, and my mid-range scenario predicts a CAGR of 17% for Shopify stocks by 2026. Some may think my forecast is too optimistic, others will find it too conservative (I think it’s more the latter), but the range of multiples at least offers a different perspective.
I don’t claim to know what Shopify’s 5 year growth trend looks like, but I think it’s reasonable enough to tell me about the current valuation – which to me looks like the most attractive valuation for Shopify since long, long lasting.
I started this article talking about perspective, and in truth that’s what Shopify is all about right now. If you don’t believe in the business, there are plenty of reasons why you can justify your bearish stance – competition from Amazon, slowing growth, employees unhappy with stock-based compensation, etc., and if you have a 6-month time horizon, I could see why you wouldn’t rush to buy Shopify stock given the current macro environment.
Still, if you plan to hold Shopify stock for at least 3 years, and ideally much longer, I think today’s price represents an opportunity for Shopify that hasn’t been seen in years. There’s a lot of short-term negativity around the company, but the company itself is still performing at a much higher level than its peers.
Sometimes you have to look through the dark clouds and realize that the sun is still there, even if you can’t see it at the moment – because one day the sun will shine again.