Shopify stock (SHOP) seems to have delivered a reality check to the bears with its Q2 results delivering excellent growth across the board and stressing the company’s profitability prospects. The e-commerce powerhouse continued to expand its internet footprint, drawing a rising number of new merchants to its platform while enabling its existing partners to achieve even greater success. In the meantime, its margins are on the rise, with free cash flow starting to snowball. That said, I am somewhat skeptical about SHOP’s valuation following its post-earnings rally and question its ability for future returns. Therefore, I am neutral about SHOP stock.
Q2 Results: Breaking Down Shopify’s Revenue Growth
Let’s first address Shopify’s impressive second-quarter results, which showcased continued revenue growth at a rather remarkable pace. Excluding the logistics business, which had been sold last year, Shopify’s revenues increased by 25% to $2.0 billion. This was backed by a significant contribution from strong Gross Merchandise Volume (GMV) of $67.2 billion, which marked a 22% increase year-over-year. This growth was, in turn, driven by a healthy mix of higher same-store sales among existing Shopify Plus merchants and an expanding merchant base globally, particularly in Europe, which saw a 32% GMV growth.
Shopify’s subscription solutions revenue also played a crucial role in driving the top line, with its revenues surging 27% to $563 million. This increase was primarily fueled by a growing number of merchants on the platform and pricing increases across Shopify’s plans. Additionally, the shortening of paid trial periods for new merchants from three months to one month contributed to this uptick, reflecting Shopify’s ability to attract and convert new users effectively.
Another notable driver was the boost in Shopify Payments penetration, which hit 61% of GMV, marking a 350 basis points increase compared to last year. Moreover, Gross Payments Volume (GPV) amounted to $41 billion in processed transactions, a 30% rise from the previous year.
Besides the obvious reasons merchants adopt Shopify Payments (i.e., achieving seamless payments without hassle), Shopify’s efforts further contribute to this transition. For instance, integrating payment solutions like Shop Pay was a strong revenue generator and facilitated $16 billion in GMV during the quarter.
Ecosystem Expansion Fuels Margin Expansion, Free Cash Flow
As Shopify continues to expand its ecosystem, the company finds it increasingly easier to enhance its profit margins and boost overall profitability and free cash flow. A key example is the growing adoption of Shopify Payments. With each transaction processed through Shopify Payments, the company benefits from percentage-based cash flow without incurring additional costs seamlessly and efficiently.
This has increased Shopify’s gross margin to 51.1% from 49.3% last year. Also, the subscription solutions segment, including the high-margin Shopify Payments business, saw its gross margin climb from 80.9% to 82.8%.
Moving further down to the bottom line, we see more positive developments. Shopify’s R&D costs, for instance, declined 46% to $349 million, while general and administrative expenses fell around 54% to $60 million. These figures demonstrate that Shopify can continue to snowball without unnecessary spending as in the past and that its overall profitability prospects remain exceptional. Specifically, the increase in gross profits and the decline in operating costs led to its free cash flow margin expanding from 6% to a much more notable 16%.
The Valuation Remains Rich
So why am I neutral on the stock when the picture seems so bright?
Despite the company’s success in increasing its revenue, the stock’s valuation appears to remain rich. With shares rallying by around 40% last week, there is no margin of safety attached to Shopify’s investment case. Even with the recent boost in free cash flow, which led to analysts revising their full-year estimates upwards to $1.36 billion for FY2024 and $1.75 billion for FY2025, the current price-to-free-cash-flow ratios stand at 65.7x and 51.1x, respectively.
These are extreme multiples both from a present and forward point of view. Will investors be willing to pay a hefty premium for Shopify stock in the future? Probably yes, given its extensive moat and industry-leading position. However, future returns could be limited, weakening the stock’s investment case. This has been evident over the years, with Shopify trading at similar levels as in 2020 despite nearly tripling its revenues during that period, mainly due to its earlier overvaluation.
Is SHOP Stock a Buy, According to Analysts?
Despite SHOP stock being overvalued, Wall Street remains relatively bullish. The stock has a Moderate Buy consensus rating based on 18 Buys and 14 Holds assigned in the past three months. At $76.40, the average Shopify stock forecast implies an 11.84% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell SHOP stock, the most accurate analyst covering the stock (on a one-year timeframe) is Mark Mahaney, a five-star analyst according to Tipranks’ ratings, with an average return of 67.25% per rating and an 88% success rate. Click on the image below to learn more.
Takeaway
In summary, Shopify’s Q2 results stressed its remarkable growth trajectory and improving profitability, with notable progress in both revenues and margins. Yet, despite these advances, the stock’s valuation remains markedly high. The hefty present and future P/FCF ratios imply that while Shopify’s operational success is outstanding, the premium stock price may significantly limit future returns. For this reason, I decided to remain neutral and stay on the sidelines for this stock.
