In a year where e-commerce has cemented itself as king, Shopify appears to be going from strength to strength; but is this meteoric rise sustainable?
The coronavirus has been massive for e-commerce. Online shopping was already on the rise over the past decade — which has led to Amazon’s (NASDAQ: AMZN) inexorable march towards world domination — but it lacked a defining moment.
However, COVID-19 forced businesses and consumers indoors, which meant companies needed to adapt to make money, leading to a bigger leap towards e-commerce in 2020 than there has been in the past 14 years. Throughout this year, Shopify (NYSE: SHOP) has found itself rising with the tide along with the likes of Amazon, MercadoLibre (NASDAQ: MELI), and even eBay (NASDAQ: EBAY).
Shopify was the darling of Wall Street long before coronavirus though, but there are many calling the stock overpriced amid a flurry of closing small and medium-sized businesses, on which Shopify’s business model depends.
How does Shopify make money?
It’s important to understand what led Shopify to become the second-largest company in Canada, rising 2,500% since its 2015 IPO — including a roughly 150% rise in the past year alone — and challenging Amazon’s dominance.
Shopify allows businesses to easily build web stores and generates the bulk of its revenue through monthly subscription packages as well as merchant solutions. Effectively, Shopify wants to become a one-stop solution for e-commerce, transactions, sales, and marketing related issues.
This business model has proven very successful so far, with Shopify reporting in its most recent earnings call last month a 47% revenue increase year-on-year to $470 million, adjusted, non-GAAP net income of $22.3 million, or $0.19 per share, in comparison to $7.1 million — or $0.06 per share — in Q1 2019. Not only this, but subscription revenue grew 34%, merchant solutions were up 57%, and it also boasted $2.36 billion in securities and cash on hand.
Risks to Shopify’s growth
While its financials look sound, there are still many risks to Shopify that some investors seem to be brushing off.
- Lack of strong economic moat
As e-commerce rises, so too do its participants, and that doesn’t just include online stores, but also payment, cloud security, and more. Companies like Jack Dorsey-owned Square (NYSE: SQ) are also in the payment for commerce space, while the likes of PayPal (NASDAQ: PYPL) and Google (NASDAQ: GOOG) could also look to compete with Shopify down the line, further diluting the market.
- The rising costs of growth
Since Shopify’s IPO, its average annual revenue growth has been more than 70%. Over time it becomes harder to sustain this rate of growth. Meanwhile, the company also is still not profitable, generating a net loss of $125 million in 2019. Shopify must now expand into other markets such as Asia, and its new Fulfillment Network could be the tool it needs to do so.
- Exposed target market
It does not seem to have had a detrimental impact on Shopify yet, but its main audience is the endangered small and medium-sized business. Three-quarters of its overall client base sits in this category and are at extreme risk of failing over the next few months as the economy slowly reopens, and especially if there is a second wave of infections.
- Its latest deal with the Devil
Many might see it is a great partnership, and hopefully it will be, but Shopify’s team-up with Facebook (NASDAQ: FB) regarding ‘Facebook Shop’ could be a dangerous one. Not only is Facebook and its nearly 3 billion users pivoting into the lucrative world of e-commerce, but merchants may also decide that they no longer need Shopify and simply opt to use Facebook instead. It’s early days yet as Facebook only revealed this news in May, but I wait with bated breath.
Is Shopify still worth investing in?
The short answer: absolutely!
Despite all of the risks, it is still entirely possible that Shopify will roar to $1,000 per share soon — after its May earnings call it topped $700 to reach an all-time high. Although the competition may be growing, e-commerce is becoming the backbone of retail, growing at an unprecedented rate, with small to medium-sized businesses leading the charge.
Shopify has built a trust with this retail world, while a company such as Facebook still suffers from an enormous mistrust issue with its customers. Though it has a long way to go yet before reaching Amazon’s heights, and there will be more bumps on the way, through its own fulfillment network, payment solutions, and cloud services, Shopify is easily the biggest challenger to the Bezos crown.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.