Apr 27 2020 - SHOP: Will Shopify Profit From Coronavirus?


CTO is saying that Shopify is handling Black Friday level traffic every day at the moment. Traffic could soon double.

Website traffic is not revenue. Comments from merchants suggest that they are not turning increased traffic into more sales. The company pulled its full year 2020 guidance.

At all-time-high share price and valuation, investors should be careful to buy into a company that will most likely see decelerating revenue growth in the short- to mid-term.

However, Shopify is still a great business and a high conviction growth stock that should benefit from long-lasting secular growth trends.

Will Shopify (SHOP) profit from COVID-19? That is a question that many investors are probably asking themselves right now. Of course, this is a very unfortunate formulation. No one “profits” from the COVID-19 crisis – it’s a devastating crisis on many, many levels. But, only from a business perspective, some companies are indeed profiting from the forced quarantines around the world. One good example is Zoom (ZM).

In Shopify's case, this question seems a bit harder to answer. The market has also struggled with it.

ChartData by YCharts

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Amazon (AMZN), which is often compared to Shopify because it also operates in e-commerce, has seen much less drawdown in the (so far) hight of the market panic, but recently Shopify has made up all the lost ground.

It made immediate sense that Shopify would trade down a bit more than Amazon in this environment: Shopify is a much smaller and more volatile company, it doesn't have the same financial strength, not as much market power, it is much more exposed to the likely weakness of small businesses, the products sold from its vendors are not "essential", and it has a lot of exposure to China's supply chain.

The sharp surge in the share price since the beginning of April does not make as much sense, intuitively. Especially considering that right now, in the middle of one of the biggest world crises in the last 100 years, shares are trading around 14% higher than their last all-time-high reached earlier in February (at which point, by the way, the stock was almost 4 times higher than at the beginning of 2019).

It's safe to say that at the moment, the market is giving investors a fair amount of FOMO when it comes to buying shares of Shopify. In times like these, investors are well served to keep a cool head despite all the positivity.

"Our platform is now handling Black Friday level traffic every day!"

If you were searching for an easy answer for why Shopify's shares have done so well lately, the above quote should do it for you. This quote comes from a tweet of the CTO of Shopify, Jean-Michel Lemieux.

Source: Twitter.

Black Friday traffic every day? Soon about to double?

That's terrific news! But it is also a very logical consequence of the coronavirus pandemic. People are not allowed or simply not willing to go to physical stores, so naturally, they go online for their shopping. Or at the least, they go there for their browsing.

The truth is traffic is not revenue. Yes, increasing traffic validates Shopify's platform and its long-term outlook. However, there is simply no way of telling how much money they will make from that increased attention.

Shopify is Pulling Guidance For Full Year 2020

On April 1, Shopify provided a business update relating to COVID-19 for its shareholders.

In this update, Shopify shared some positive-sounding data insights:

  • "Early signs indicate brick-and-mortar businesses, impacted by the dropoff of foot traffic resulting from stay-at-home policies, are pivoting to online as consumer demand shifts.

  • Merchants are heavily leveraging discounts to boost sales.

  • Sales trends are aligning to specific industries based on the evolving environment, consumer concerns and needs.

  • In March, we terminated thousands of merchants charging unfair prices or making false claims about COVID-19-related items such as face masks or hand sanitizers."

At the same time, the company pulled its guidance for the full year 2020:

"Shopify ended 2019 with momentum that continued into January and February of 2020. This will enable us to report revenue and adjusted operating income for the first quarter within or ahead of the range of expectations provided on February 12, 2020, despite the global economic disruption that emerged in March triggered by COVID-19. Given the uncertainty surrounding the duration and magnitude of COVID-19, Shopify is suspending the financial expectations provided for full year 2020."

Just to be clear, that's bad news. When things are running better than expected, companies don't pull their guidance. They usually keep quiet, blow-out the next earnings report, and then give prudent guidance (cautioning investors that it is tough to predict the future and that recent positive momentum should not be extrapolated). Just like Netflix (NFLX) did the other day.

Merchant Comments Are Not Encouraging

On top of the slashed guidance, comments made by merchants are, at least for now, not very reassuring.

You can get a feel for the situation if you browse the Shopify community discussion boardOf course, the information there is very anecdotal. If your online store is booming right now, you won't have time to write on community boards. Thus, posts will most likely lean towards being negative. Still, you can see some valid concerns expressed on these boards that do represent a (possibly significant) part of Shopify's merchant base. These insights are also important to note for investors.

For example, one Shopify Partner wrote: "I know that dropshippers or merchants connected with China are hit pretty bad."

Another poster shared: "I sell expensive clothing to people going to large gatherings (Oktoberfest or German clubs) that happen for a season every year. 15 years in business. I assume this year will be devastating."

Also: "My sales have been down the past 2-3 weeks, though my traffic has gone up. According to shopify my store's traffic is in the top 7% of stores that launched the same week as I did, back in fall of 2018. I have had less new customers making purchases. Most orders have been from loyal customers."

In many comments, merchants were also complaining about long shipment times and their inability to ship products to customers effectively. Some merchants are even pausing their stores to reduce the monthly fee.

However, there are also some success stories, like this one: "Our sales have gone up, so much we had to put our store in catalog mode to stop the orders from climbing."

Revenue Impact on Shopify Completely Unclear – Valuation Not Impacted By Uncertainty

Clearly, it's all about being in the "right" industry right now for online merchants; and not relying on international supply chains. The right industries have to be selling hygiene products, respiratory masks, groceries, pharmacies; basically, the essential items that are needed in this crisis. It's well documented that Amazon had no trouble shifting their focus on these items while still being more than utilized to capacity. It's a bit less clear how Shopify merchants will be doing as a whole.

My feeling is that in the short- to mid-term Shopify will see a bit more revenue deceleration than in the past. However, as I'm writing this, I'm still wrestling with my conclusion: On the one hand, e-commerce has undoubtedly gained more importance and people are using online-services more than ever. On the other hand, Shopify already pulled its guidance, merchants seem to be quite negative, and, quite frankly, logic dictates that there has been a broad pull-back in non-essential consumer spending.

In one word, there is a lot of uncertainty. Usually Wall Street doesn't like this. Which makes the recent share price surge a bit puzzling.

ChartData by YCharts

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Just look at some other platform businesses, that are heavily dependent on usage fees. The difference in the valuation premium is quite astounding at the moment.

To be clear, however, in my opinion, Wix.com (WIX) doesn't even hold a candle to Shopify competitively. Also, Square (SQ) is obviously one of the most hard-hit companies as it relates to their POS-business and only holds up because of a potentially booming Cash App.

Still, if you are buying Shopify right now, you are paying 45 times their trailing sales. If you are considering that Shopify's gross margins are "only" around 55%, which puts its trailing EV to gross margin ratio to 82, the shares look even more overvalued at the moment. Actually, according to this metric, Shopify's shares have a higher valuation than Zoom (ZM), which has an EV to gross margin ratio of 78 (EV/S of 63.45 divided by gross margin of 81.47%).

And this is on the background of Shopify probably just reaching their Q1 revenue targets (only because of strong January and February) and complete uncertainty as to how high revenue will be for the full year. As a reminder, the company guided for revenue in the range of .130 billion to .160 billion (between 35% and 36.9% year-on-year growth) in its Q4 2019 earnings release. In 2019, Shopify grew revenues at 47%; in 2018 growth was 59%. In all likelihood, revenue growth for 2020 will be below 35%, which brings the forward EV/S to at least 33 or higher. This is a high multiple in any circumstance, but especially so, in this time of economic uncertainty.

Closing Thoughts

I have been on the record on this site saying that valuation doesn't really matter in the long-term, and I stand by that assessment. For full disclosure, Shopify makes up a sizable position of my portfolio (8-9% at the moment) and I intend to hold that position until I see the business deteriorating meaningfully – and I do not consider the current coronavirus crisis as a business deterioration, regardless of how big its impact on Shopify may be.

If you are asking yourself, why I decided to hold the shares, despite all my cautions in this article, there are a couple of reasons:

  1. I don't like selling my winners.
  2. I still believe in the company's long-term potential. Shopify's market is huge and they barely started penetrating it. Also, the aforementioned increase in platform traffic is a good indication of the long-term viability of Shopify's market and business.
  3. The market usually knows more than the individual investor, and certainly more than me. I may be missing an important piece of the picture here which the market is aware of (which I would be glad to read about in the comment section).
  4. In my concrete case, I also have to consider tax consequences. Because of my low-cost basis, I would take an approx. 0 per share cut (around 20% immediate drawdown), if I sold my shares here.
  5. While valuation seems very stretched at the moment, this problem can be solved by many years of compounded growth, which I think Shopify has ahead of itself.

Nevertheless, the valuation of shares considering the current environment doesn't make it a compelling investment at the moment. I understand that investors are flocking into quality investments who might have (relatively) more upside from the coronavirus crisis. Also, the comments by the CTO about increased traffic are great news. But considering that the company will most likely see decelerating growth under very high uncertainty, while the stock price and valuation are rising to all-time-highs – it simply doesn't add up.

Shopify is a great company and, all in all, still a great investment. I would just urge readers not to fall to their FOMO at the moment. Remember when Tesla (TSLA) was priced at 0 a share and you probably thought: "Oh god, if I don't buy it now I will totally miss it – this is the future!" At least for now, that didn't turn out so well. I have a feeling it could be a similar situation with Shopify at the moment.

My strategy is simply to sit on my hands and do nothing (a strategy that generally has served me quite well over the years and, so far, also during the COVID-crisis). If you have a knack for these things (I don't), it's probably a good time to move some of your money out of Shopify to other positions. If you can't resist your FOMO, it could be smart to keep the size of a new position small at this time.

Please Follow, Like, and join the discussion in the comment section. Stay safe and healthy!

Disclosure: I am/we are long SHOP, AMZN, NFLX, SQ, ZM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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