Canada-based Shopify Inc. (NYSE:SHOP)(TSE:SHOP) is facing increasing downward pressure due to external forces. After all the selling, SHOP’s market capitalization is roughly the same as its pre-pandemic level. So, will SHOP rebound or is buying into it more like trying to catch a falling knife?
SHOP is a materially better company than it was pre-pandemic, however it has lately been facing a poor economic backdrop. The pandemic accelerated Shopify past its high growth stage and now the company needs to be evaluated through a different lens. I am Neutral on SHOP.
Before and After the Pandemic
Note: Values are in USD
Before the pandemic, Q4 2019 revenue stood at only $505 million, while most recently, the same period in 2021 saw revenue of $1.38 billion, a stark difference. Yet, the market capitalization has remained materially the same at ~58B.
The share prices between 2019-2021 were supported by the idea that high revenue growth would continue, margins would expand, and the economy would continue to boom.
Revenue grew 41.25% year-over-year for Q4 2021, and was still comparable to Q4 2019’s 46.80%. The pandemic boost had shot growth up to 93.47% for Q4 2020. Meanwhile, the story is similar for yearly revenue growth; 57%, 86%, 47%, for 2021, 2020, 2019 respectively.
So how can the market capitalization be more-or-less the same? The answer lies in the expectation of growth and what else the market can get for the same price elsewhere.
Regarding the former management is expecting lower growth in the first half of 2022. Due to waning pandemic ecommerce trends, a revenue share reset, and marketing investments not kicking in until the second half of the year.
Right now SHOP is still trading at a 13.7 price-to-sales, which implies the market is still expects significant growth. This metric is relatively high compared to competitors Amazon (AMZN) and Etsy (ETSY), who have respective price-to-sales of 3.2 and 5.6.
Even though SHOP is down 70%, a 13.7 price-to-sales is still a high valuation, just not as extreme as the 50 price-to-sales it was seeing in 2021.
The difference is even more significant when comparing price-earnings trailing twelve month ratios of 82, 45, and 24 for SHOP, AMZN, and ETSY, respectively. Shopify’s adjusted earnings saw a large one time accounting gain of $2.86B in its holdings of Global-E (GLBE).
SHOP’s share price got ahead of its financials during the long market bull-run and is now consolidating down to where the fundamentals can support the valuation.
Market Correlation
Once the various stimulus packages came into effect around the world, assets rose fast, and in many cases became overvalued. Now that the stimulus has ended and central banks contract monetary policies, we will continue to see growth expectations plummet and valuations evaporate.
The tech heavy Nasdaq 100 (NDX) is down over 20% from its all-time-high in November 2021. Although SHOP is not in the index itself, they have similar attributes of being growth and tech oriented. SHOP has a high correlation of 0.85 with the index.
SHOP has a high beta of 2.2 (three year, monthly returns), meaning that for every 1% move in the NDX, SHOP is expected to move 2.2%. Since the NDX dropped 20%, one would expect a 44% drop in SHOP statistically. However, SHOP has dropped 70% in the same time period. So, that means the market perceives SHOP to have more downside risk than the market.
External Pressure
The main cause of the market’s fear is inflation and the resulting effects, including interest rate hikes and recession.
SHOP has negative net debt, meaning they hold more cash and equivalents than debt, so unlike many other companies it will not face risk of rolling debt at a higher rate. However, that does not mean SHOP is not affected by interest rates.
Many of SHOP’s customers may have taken on debt, and will face increased debt driven risks like default, which would reduce SHOP’s gross merchandise sales.
The bigger risk for SHOP is economic contraction, as its underlying merchants largely provide discretionary products which are generally the first thing consumers pass on when they need to tighten their wallets.
SHOP is facing more external changes than just the broad economic conditions, competition is increasing. AMZN is introducing ‘shop with prime’ which allows third-party merchants to integrate AMZN’s shipping and payment system with their own websites. Although it does not have the same depth of services as SHOP’s offerings, it may be a substitute for some merchants. Since SHOP’s valuation has been heavily attributed to long-term growth prospects, increasing competition which takes even a small portion of its market share can have a drastic effect.
Wall Street’s Take
Turning to Wall Street, SHOP earns a Moderate Buy rating with 15 Buy and 14 Hold ratings assigned over the past three months.
The average SHOP stock price target of $986.60 implies 114% upside potential.
Conclusion
For a long time SHOP has been overvalued, but is now more reasonably priced. However, external conditions are not in SHOP’s favor, and could hamper growth in the short to medium term. I am more hesitant than the analyst consensus, and remain Neutral on SHOP.
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