Canadian e-commerce platform Shopify (SHOP, Financial) has grown steadily over the last several years and that trajectory looks set to continue for the foreseeable future. We remain only moderately bullish because the company has yet to turn a profit.
About Shopify
Founded in 2004, Shopify provides a user-friendly e-commerce experience for its customers and vendors, big and small. Serving a variety of vendors, it almost doubled its client base over the last year to well over 600,000. From young entrepreneurs selling anything from crafts to clothing, to larger entities hoping to sell their products on the Internet, Shopify has positioned itself well within its market.
E-commerce is an increasingly exciting and growing business, and we feel positive about Shopify’s future. Still relatively small, it has room for growth.
Lots of growth
Shopify has demonstrated consistent growth over the past several years, and while it continues to run at a loss, we expect revenue to grow steadily enough in the coming years to bring the company into the black.
A positive trend is further developing. For first quarter 2018, Shopify reported non-GAAP earnings per share of 4 cents, up significantly from the 4-cent loss it reported just one year ago. And, earnings beat expectations, entering positive territory for non-GAAP earnings for the first time in the company’s history.
Earnings per share have consistently beaten expectations over the last several years, including frequent earnings surprises. Over the last four quarters, for instance, Shopify has produced four straight earnings report surprises, beating market expectations by 25%, 47%, 75% and 30%. Despite this, Shopify has yet to report a positive earnings per share number for GAAP earnings.
Likewise, revenue has surged. After jumping 90% last year to $389 million for 2016, revenue spiked to its highest point ever for Shopify, a total of $673 million for 2017, a 73% increase. Average yearly growth in excess of 80% bodes well for the company as it moves forward and continues to rapidly growth and keep apace with its growing client-base.
But costs crimp profits
Cost and expense analysis reveals a mixed bag. Gross profit has grown about in line with revenue, indicating cost of revenue has remained steady. In 2016, Shopify made $389 million on $180 million cost of revenue (46% of revenue), while in 2017, Shopify earned $673 million on $293 cost of revenue (44% of revenue).
Cost concerns worth noting
The most significant cost concerns for Shopify land in the operating expense category. As revenue and growth have rapidly moved upward, the costs of getting there have as well. Research development costs exceeded $135 million in 2017 and SG&A expenses topped $293 million, 83% and 70% increases from 2016, respectively. Herein lies the reason why Shopify continues to run at a loss despite highly impressive revenue growth.
We certainly understand the value in Shopify’s development expenses as it continues to perfect its product and service, and likewise see the benefit in marketing and sales expenses as it pursues a goal of rapid client expansion. Therefore, the fact that Shopify reported a $40 million loss for 2017 does not set off alarms bells just yet. We can see the rational of its strategic choices. We expect sales to continue to benefit from these choices.
A host of advantages
One of Shopify’s particular strengths has consistently been its flexibility, financially and strategically. As its customer base grows and diversifies, Shopify has shown willingness to change and adjust. This is always something we like to see from companies we follow.
Shopify has made different adjustments to its platform aimed at helping its smaller clients, as well as its larger clients with more complex needs. This ability to meet the needs of its clients bodes well as it, if expectations hold, surpass well over a million customers this year.
Shopify can harness strategic flexibility moving forward, as Shopify’s management wrestles with how to produce a profit, how to maintain its meteoric growth figures and how to best position for the future.
Building a stable market niche
Further, Shopify has positioned itself well in the e-commerce market over the last several years, establishing important business relationships and partnerships with Internet giants like Facebook (FB, Financial) and Amazon (AMZN, Financial), the significance of which is twofold.
First, Shopify can use the might and reach of its partners to help grow its business and give access to its clients. One can’t have any better partners in terms of user access and visibility than the world’s top e-commerce site and the world’s largest social network (not to mention easy functionality with eBay and Instagram).
Second, by creating relationships filled with goodwill, Shopify can help prevent its massive collaborators from entering into direct competition with its business.
Verdict
We see potential in a longer-term play on Shopify. The e-commerce industry continues to face moderate levels of volatility, which means Shopify’s stock price might swing a bit. This is to be expected and is why we are encouraging you hold the stock and try to let short-term swings wash over you.
We see significant value in a company that is consistently producing significant growth, particularly over the last two years, almost doubling sales in both. As Shopify continues to grow, we expect management will make the necessary adjustments to bring a profit. In the short-term, spending to produce strong growth isn’t a bad idea.
This investment comes with certain risk, as all do. We see the general state of the economy, spending power and trends, and e-commerce/retail trends to have a certain affect on Shopify and its stock price. (There’s even a push for the Federal Trade Commission to investigate Shopify’s practices because it’s performing so well). But, overall, the numbers and value are clearly there.
Disclosure: I/We own no stocks discussed in this article.
This article was co-authored by Clyde Wm. Engle Jr., an analyst with Almington Capital.
