The cloud-based e-commerce specialist is not well suited to perform during the pandemic.
This article was originally written by Jeremy Bowman of The Motley Fool
Shopify (NYSE:SHOP), the e-commerce software company, has been one of the best-performing stocks in recent memory. Shares nearly tripled in 2019, and they were following a similar trajectory this year as the company put up impressive growth numbers and established itself as a leader in its industry.
However, with the pandemic taking over much of the world, the winds have shifted. Not only are retail storefronts in much of the U.S. and Europe shutting down, consumers have cut their discretionary spending to focus on food and essentials as they stock up and prepare to stay at home in accordance with local guidelines.
Surprisingly, despite being a high-priced growth stock, Shopify has actually outperformed the market during the coronavirus-related sell-off that started last month. Shares are up 12.5% year to date compared to a 18.6% decline in the S&P 500. However, investors could be overestimating the stock’s ability to withstand this crisis.
1. SMBs are going to take a hit
Small- and medium-sized businesses (SMBs) are at the core of Shopify’s business. Even in its highest-tier subscription plan, Shopify Plus, many of its subscribers qualify as SMBs. These include bed-in-a-box maker Leesa, sock seller Bombas, and cosmetics company 100% Pure. Turning a profit as an online retailer isn’t so easy even in the healthiest economy, but consumer shopping habits have been turned upside down during the pandemic. Target, for example, said that comparable sales of food and beverages have jumped more than 50% so far in March, while comparable sales of apparel and accessories have fallen by more than 20%. Shopify businesses tend to sell items like apparel and accessories rather than the food and essentials consumers want during a time of crisis.
Shopify is well aware that its partners are suffering. The company has reached out on Twitter to ask what they need and how the company can help them. Among other efforts to help its sellers, the company is making gift cards to help them bring in cash flow now, offering loans through Shopify Capital, and extending its free trial for new subscribers. It’s admirable that Shopify is reaching out to its partners and trying to help them in a time of need, but many may not survive the lockdown or will see a significant decline in business even if they do.
It’s clear that these businesses are already feeling the impact of the outbreak. Facebook, one of the main outlets Shopify sellers use to advertise, has already seen a weakening in its ads business in countries aggressively responding to COVID-19. That’s a sign that companies are seeing less demand in the market, and that pattern is likely to continue through the crisis.
2. We’re headed for a recession
Nearly 3.3 million Americans filed new unemployment claims on Thursday, quadrupling the prior record in a single week. Federal Reserve Chairman Jerome Powell also said that we may already be in a recession, which is generally defined as two straight quarters of negative growth.
Even after the outbreak recedes, much of the world is going to be in an economic funk. Millions are losing their jobs, giving them less money to spend, and the impact of unemployment increasing and businesses closing, at least temporarily, will trickle through the economy. Global supply chains, meanwhile, are also being strained as the virus spreads. Despite the federal government’s efforts, we can’t simply flip a switch and go back to a pre-COVID-19 economy.
Since many of Shopify’s sellers specialize in the kind of discretionary products that penny-pinching customers are likely to forego, its financial results will take a hit for as long as an economic downturn lasts. Revenue from its merchant solutions is primarily connected to payment processing, so it has a direct stake in sellers’ sales. It will also lose subscription revenue if sellers have to fold up their shops, or if they fail to grow revenue and therefore don’t need to upgrade to a higher Shopify subscription tier.
Last year, the company spent about 30% of its revenue on sales and marketing. In a recession, customer acquisition costs will almost certainly increase, so the company will need to either spend more on marketing to achieve the same growth rate or accept a slower one.
3. The price is still too frothy
Even after shedding almost 18% from its February high, Shopify still trades at a price-to-sales ratio of more than 30, making it one of the most expensive stocks on the market. Investors seem to have bundled the company in with other software-as-a-service stocks, but that’s a mistake. Unlike most cloud-computing companies, which cater to corporate businesses and often provide necessary infrastructure, Shopify and its sellers are reliant on end consumers, whose spending is generally the first to go in a crisis. For much of the past month, Shopify even traded in tandem with Slack, the workplace messaging software company that has seen sign-ups soar during the crisis. That pattern, which has since broken, seems hard to justify.
Investors may be giving Shopify the benefit of the doubt as the stock has historically performed so well and does have a number of competitive advantages. However, the ability to thrive during a recession or in the current pandemic isn’t one of them. Results in the coming quarters could be ugly. At its current valuation, it will be difficult for the stock to withstand a sudden slowdown in growth.
Long term, Shopify is likely to recover, but investors should expect things to get worse before they get better.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.
Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Jeremy Bowman owns shares of Facebook and Target. The Motley Fool owns shares of and recommends Facebook, Shopify, Slack Technologies, and Twitter. The Motley Fool has a disclosure policy.