To buy the dip, or not to buy the dip? ...that is the question we'll be asking quite a few times over the next few weeks. The dip, although painful, is a welcome opportunity to buy into some great companies for our long-term investments. Is Shopify (SHOP) one of them?
Okay, first let's talk about the dip... it's a pretty significant one. One of the metrics I'm looking at evaluating any dip right now, is how are valuations relative to pre-COVID levels. Shopify, fortunately (or unfortunately) meets that metric. They're trading at about 20x EV/Sales... which, still, is not cheap.
We, then, have to ask whether the business fundamentals are better or worse so that we can justify this price. If there's any time to justify prices... it's now.
I'm sure you're familiar with the Shopify model, so I'll just skim through it... but essentially it's a web-based platform that allows merchants to setup e-commerce stores and sell to end-consumers. It's the simplest way to setup and sell an online store. They have small, medium, and large e-commerce businesses on their platform. And, being a user myself, I can say it is very easy (relative to competitors)... and they've built something amazing. They likely aren't going anywhere. It's a strong enough moat, imo.
The Key Performance Indicators (KPIs) for Shopify, which we'll dive deeper in our valuation and forecast are monthly recurring revenue (MRR) and gross merchandise volume (GMV). The more customers they onboard, the higher their recurring subscription revenue, and the more they process payments through their platform, the more they generate from Shopify payments & platform fees.
As a reminder, all valuation sheets are available to premium members of The Hawk Letter and Discord. I highly recommend you join, to make your own assumptions and investment thesis :)
The biggest drivers of the valuation, as I mentioned, are MRR and GMV. These grew 53% and 96% in 2020, which was insane... but, mostly due to COVID. They were also profitable, for the first time, with an 11% net income margin. As COVID winds down (hopefully), so does their growth and margins... which starts to make sense.
Q3 2021 the slowdown became evident, but what was more concerning was the margin compression (after removing the effects of unrealized gains on Affirm warrants and impairment from closing office spaces). The remote workforce, by the way, should help improve margins going forward.
The big question to answer is what do we expect the growth rate of GMV and MRR to be going forward. There has been a clear slowdown in ecommerce growth, which is concerning investors. Looking historically, Shopify has captured a 3-5x growth rate from global ecommerce growth annually looking back from 2018-2021. That multiple has been going down, so let's assume they meet the forecasted CAGR for the next few years, then we're giving them a 30% CAGR, and net margins are about 5% (to be conservative), then the company is still expensive.
An intrinsic value of $500 per share, and factoring in further multiple contraction... I think $450-500 might be where its trading at a bear case. Because, I'm more conservative, and not factoring in massive growth, it's quite a difficult case to make.
Shopify has partnerships with Google, TikTok, Affirm, ERP systems, and is constantly improving. I applaud them for that. In order for Shopify to take the next level, they have to be competing directly with Amazon... that's a tough thing to do. I think they can, and it's possible.. but, in my bear case, I'm just not pricing that in because ecommerce growth (as a whole) is something that concerns me.
Because of these factors, and the current macroeconomic environment, investing in Shopify (although a 50% dip is in play) is not for me. I believe the company is way too richly valued, and there are other opportunities in this dip that I am looking for. If we look at a company like ADBE, although a completely different business, is approaching really attractive multiples on recurring revenue. I just believe there are better opportunities in this dip.
Hope you enjoyed the content, and I will get back to hunting the dip for us!
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