This article was originally published on Forbes on May 5, 2022,11:44pm EDTForbes on May 5, 2022,11:44pm EDT
Shopify reported slowing growth and rising expenses. As of late, the market tends to penalize companies that report slowing growth and declining margins and Shopify has not been spared. However, with Shopify’s stock in the gutter, is now a good time to buy the company? The answer is that it depends on your time horizon. The long-term story is intact but there are also opportunity costs to holding a stock that must be considered.
By now, we all know that macro conditions are affecting most consumer-facing businesses. In addition to macro, Shopify faces high investment costs for the Shopify Fulfillment Network (SFN) coupled with the unknowns around the company’s growth rate now that the economy is reopened. Essentially, it’s hard to model this because the return on the investments made in SFN will not appear until H2 2023 or early 2024. This presents a predicament for Shopify’s stock if the market is uncertain of how SFN will perform.
What could overcome these headwinds would be Shopify’s strength in merchant software solutions including an omnichannel approach and the company’s social commerce inroads. Because Shopify offers an omnichannel strategy through point-of-sale (POS) and various products, the company may be able to regain the Street’s confidence even while e-commerce continues to soften.
Notably, one more headwind that Shopify will have over the next three months is the company’s pattern to not provide guidance. This may have worked well when the ecommerce sector was on fire, but investors need more to go off of with macro putting pressure on the consumer-facing companies. This lack of visibility may work against the company while others are striving to reiterate full year guidance and discuss more granularly their current revenue growth.
Shopify’s Q1 2022 results
In the most recent quarter, Shopify’s growth slowed as GMV increased just 16% YoY, nearly half the 31% YoY growth rate the company reported in the prior quarter. Total sales increased 22% YoY to $1.2 billion, which was the slowest rate of growth since Shopify went public.
The company stated the lower revenue was due to Omnicron easing and inflation pushing consumers towards discount retailers in Q1. Long-term, management believes despite the macro backdrop that “e-commerce will continue to penetrate commerce overall”- a $6 trillion market.
Subscription sales increased just 8% YoY to $345 million while Merchant services increased 29% YoY to $859 million. Management noted that a change in how they share revenue impacted subscription sales, without this subscription sales would have been up 15% YoY.
The tough macro environment flowed down to gross margin, which declined 354 bps YoY to 53%. Shopify also guided that Merchant sales would grow 2x as fast as Subscription sales in 2022, which is likely pressuring Shopify’s valuation. This is because Merchant sales are lower margin and implies further margin compression.
Also pressuring gross margin were investments in Shopify Fulfillment Network, which are expected to pressure earnings for the next couple of years. During the Q1 2022 call, management stated that “the expectation [for SFN] is that scale will still be towards the back half of 2023 and into 2024, and we've always said that's where the unit economics really start to shift to favorable. So, we fully expect the volumes to continue to increase into that timeframe.”
In other words, there will be a delay until Shopify’s income statement reflects the benefits of scaling up its fulfillment network. In the meantime, the optics of slowing growth and rising expenses are temporarily pressuring Shopify’s multiple. However, these investments are necessary to support long-term growth and Shopify’s multiple will likely improve as the benefits of scale are reflected in earnings.
Adjusted operating income declined YoY from $210 million to $32 million. The decline was driven by a ramp in R&D and sales and marketing expenses, coupled with the investments being made in SFN outlined above. Shopify also reported a large $1.6 billion unrealized loss during the quarter related to its investments in Affirm and Global-E, which have seen their equity values more than halve since last year. The rapid decline in Shopify’s equity investments has also likely impacted by the company’s valuation due to a lower sum-of-the-parts valuation.
Nevertheless, last year Shopify had reported over $1 billion in equity gains from the aforementioned investments, and excluding the impact from equity investments, adjusted earnings per share were $0.20, which missed estimates of $0.65. As mentioned above, margins and earnings were impacted by numerous short-term trends.
