(TSE:SH) Shopify’s growth prospects are the key to upside in its shares
Juri Zguri | Ubika Research Analyst | May 16, 2016: Shopify Inc.’s (TSE:SH) (NYSE:SHOP) stock price has weakened during the past two weeks despite reporting Q1 results that beat expectations. Although it is still relatively expensive compared to its peers, the Company’s rapid growth could make Shopify’s share price look like a bargain over the next couple of years.
Recent Events: Strong Start to 2016
Shopify had its IPO in May 2015, making this month the start of its second year as a public company. The Canadian e-commerce stock currently trades at US$26.95, which is 28% off its 52-week high of $37.39. Its first-quarter results were released on May 4, 2016. Revenues and guidance were unanimously better than the Street expected, however the guidance on operating income was lowered mainly due to recent Canadian dollar strength (which relatively increased expenses as they are predominantly denominated in CAD), as well as the acquisition of Kit CRM (~1.5-2.0 million). Notably, management reiterated that the Company will breakeven by the fourth quarter, 2017. In addition, Shopify ended the quarter with >275,000 merchants, representing a phenomenal 61% growth rate YoY. Despite the mostly positive news, its stock price took a >10% dive following the filings.
Brokerages were quick to release update reports with adjusted price targets under the new guidance figures. The following chart details the analysts’ updates:
| Analysts From: | Price Target |
| Credit Suisse | $34 – unchanged |
| Morgan Stanley | $34 – unchanged |
| RBC | $37 – unchanged |
| Piper Jaffray | $32 – change from $27 |
| Roth Capital | $40 – change from $35 |
| Canaccord Genuity | $38 – unchanged |
| Paradigm | $37 – initiating coverage |
Average Price Target: $36.
Implied Upside from Current $26.95: 33.6%
With that being said, let’s take a look at some positive characteristics that are driving value for Shopify.
Investment Thesis
1) Focus Placed on Growth in Subscription Segment & Increasing Base Merchants Numbers
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This is where Shopify’s competitive advantage is apparent. The Company’s business model is recurring in nature. The customer cycle looks something like this:
1) Small businesses subscribe to the Company’s website platform
2) Shopify helps create and expose website through its services, boosting sales and efficiencies
3) Businesses are incentivized to remain as subscribers and renew contracts. Additionally, with the boosted sales, merchants may opt to buy additional sales channels and solution packages.
To top it all off, the Company’s blog (Shopify Blog) has a large reach with over 20 million page views.
This initiative helps expose the brand onto the Internet, where the vast majority of its business lies.
One key indicator we followed was monthly recurring revenue (MRR). MRR has consistently been ~5% of total annual revenue, although we see growth in this front as the number of merchants (~275 thousand) add up. This is further explored by calculating the growth figures YoY for MRR, which sits at an annual 72% for both periods. Although a 72% growth rate is certainly not an easy feat to maintain, we believe Shopify has untapped potential in its market that will help this indicator remain strong.
Figure 2. Monthly Recurring Revenue
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Source: Company Filings
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2) Well Positioned in a Rapidly-Growing Industry
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Online commerce is an undeniably growing industry. This can be clearly exemplified through Amazon’s ascent in recent years: up 65% from this time last year. Shopify’s ecosystem will continue to grow as more and more businesses realize the importance of eCommerce.
Figure 3. Google Trends Data in the US
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Source: Company Filings
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While eCommerce continues its advancement, a more particular growth story is that of mobile commerce (mCommerce).
Currently grabbing over 1/3 of the global eCommerce market, we believe Shopify is poised for rapid growth on this front as over 51% of orders in the Q1 report came from mobile.
Businesses are continuing to improve their mobile websites and platforms, however many are reluctant to invest much capital due to the low conversion rate (Number of Sales/ Number of Users) that comes with mCommerce, particularly in the United States. The desktop market had a ~4.55% conversion rate in 2015, while smartphone shoppers converted views into sales only ~2.46% of the time (as analyzed by Criteo; see figure 4).
That being said, when examining mature smartphone markets (such as Japan), businesses should be able to see the importance of mobile marketing and exposure. The conversion rate for the smartphone funnel is ~9.35% in Q1 2015 for Japan. This exemplifies weakness in the payment system in the US, giving merchants more incentive to incorporate Shopify’s services into their mix. This goes for eCommerce, as well as the rapidly-growing segment of mCommerce.
Figure 4. Smartphone Conversion Rates in US vs. Japan
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Source: Criteo
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Valuation: Numbers Need Improvement
Shopify is still operating at a net loss, and plans to continue on that front until the end of 2017. On an EV/2016E Revenue basis, we think the stock is still relatively expensive compared to its peers. The company trades at ~7.5x, which is considerably higher than the peer’s average of 4.0x.
These figures are based off of a 2016 revenues estimate of $345 million, representing a 68% growth rate from its 2015 actual revenue figure of $205 million. The comparable companies were cloud based and subscriber focused.
While the lucrative valuation may be somewhat justified by the rapidly-growing user base, we think it has room for improvement. This may materialize as the Company continues to innovate new revenue-generating mechanisms, as well as turn operations profitable.
Catalysts
• Excess cash balance of ~190 million is substantial enough to sustain addition capex plans (~20 million related just to Europe offices) as well as favorably M&A used to strengthen merchant services and/or exposure to merchants via social media and marketing.
• Social media trends provide greater-than-expected exposure, thereby increasing merchants added at a faster pace.
• Launch of new innovative merchant solutions adding to the cycle of recurring revenue, as well as further incentivizing new business.
Risks
• Appreciating CAD, increasing opex for Shopify as the majority of expenses are incurred in Canada. We think this risk has reached its full effectiveness and expect it to diminish as the USD enters its trough, and perhaps an appreciation phase.
• Increased competition as competitive moat is largely intangible (brand equity). Commerce giants like Amazon may intend to enter the small business eCommerce world, and thereby impede on Shopify’s story. That being said, we believe this risk is not substantial as 1. Amazon has already attempted (and not succeeded) on this front, and 2. Larger players would be better off acquiring the Company itself, which acts as a significant catalyst to Shopify’s share price.
• Negative investment sentiment as the Company continues to reiterate profitability in 4Q17, while the top-line continues to grow with strength. This signals continued cost issues/initiatives that investors may not be too fond of. We believe these are cost initiatives and not issues as the Company continues to grow its subscriber and merchant base. That being said, Shopify’s margins are key figures everyone will have their eyes on during Q2 filings.
Concluding Thoughts: Shopify’s growth prospects are the key to upside in the stock. It is in our opinion that small businesses will continually look at Shopify for affordable and effective technology and solution strategies for revenue generation. The one downside we notice towards this investment is its relative valuation, which shows the stock is trading at a premium to its eCommerce peers. That being said, we believe its comps should normalize as the Company continues its rapid growth.
