Shopify (NYSE:SHOP) is due to report its FQ1 earnings card on May 5, with the pandemic winner sitting nearer to its COVID bottom. The market has parsed SHOP stock’s massive growth premium and digested it accordingly. For a stock that used to trade at a high of 260x NTM normalized P/E, it cannot afford to make mistakes nor demonstrate weakness in execution.
However, its poor execution in the face of the reopening headwinds in its FQ4 card reminded Shopify investors of the embedded growth premium that they paid for. Therefore, even its recent stock split announcement did overturn its weak momentum, as investors bailed out of Shopify stock.
Furthermore, Amazon’s recent Q1 earnings release also spooked e-commerce investors. Notably, Amazon’s (AMZN) growth deceleration moderated more than expected. In addition, Amazon also dealt with increased costs headwinds. These include fixed costs deleverage linked to its overcapacity challenges, exacerbated by inflation and supply chain disruptions.
As a result, Shopify’s Q1 estimates have also been revised markedly downwards, as the market expects Shopify to report a tepid release.
With SHOP stock down almost 75% from its November highs, it’s challenging for its investors to fathom that it could fall even further. But we believe AMZN stock’s downward momentum could continue to impact SHOP stock. Moreover, given SHOP’s implied growth premium, we remain concerned that the market makers could push it further to its COVID bottom before staging a reversal.
With an implied downside of 32% to its COVID bottom, we revise our rating on SHOP stock from Buy to Sell. We also encourage investors to use any potential post-earnings rebound to rotate completely or cut exposure in SHOP stock.
Shopify Stock’s Growth Premium Is Hard To Justify
SHOP last traded at an NTM normalized P/E of 160.15x, with an NTM FCF yield of 0.28%. Therefore, we think there’s little doubt that the market is still expecting Shopify to post significant growth in its DTC e-commerce growth engine moving ahead.
But we can also observe the significant deceleration in Shopify’s topline growth as its pandemic tailwinds wore off. The consensus estimates over its revenue growth in Q1 have generally been maintained at 25.6%. However, we observed significant markdowns in its EPS estimates. Notably, Shopify is estimated to report an adjusted EPS of $0.67 in Q1 (Vs. $0.78 at the end of March). In addition, its GAAP EPS estimates were also revised from -$0.55 at the end of March to -$0.60 recently.
Given Amazon’s poor operating performance in its Q1 card, we believe the revisions were justified. Moreover, Shopify’s operating challenges are compounded by its investments in fulfillment. These investments are expected to thrust its GAAP EPS into negative territory. Furthermore, its FCF margins could also be significantly impacted, as seen above. As a result, Shopify is expected to report an FCF margin of just 2.7% in FY22, against FY21’s 9.8%.
Shopify Is Facing Challenges From Apple, Meta, and Amazon Concurrently
Apple’s (AAPL) ATT framework has also impacted Shopify’s close partnership with Meta Platforms (FB) for advertising. Shopify had already diversified its reliance on Meta by partnering with TikTok (BDNCE) over the past year. However, the massive scale and reach of Meta are highly challenging to replicate.
Furthermore, FB has also been actively moving into in-app e-commerce to leverage its first-party data to navigate the new ATT era. Therefore, we think Meta’s partnership with Shopify could be fraught with potential new friction points moving forward.
Furthermore, The Information reported in April that Shopify was reticent in urging its merchants to activate Meta’s Conversions API (CAPI). As a result, it has hampered Meta’s ability to alleviate the challenges from Apple’s ATT. The Information added:
But when Meta dangled a potential partial solution for Shopify—and asked for help getting its millions of merchants involved automatically—the e-commerce company demurred on multiple occasions. – The Information
We suspect Shopify’s partnership with Meta could have peaked, given Meta’s internal challenges with ATT. Therefore, we are keen for management to update whether the company will be eager to leverage its first-party data and launch its retail media ads platform. It’s well-known that Shopify possesses highly valuable data through its Shopify Audiences data aggregation. But management has not offered enough ideas on how they intend to monetize advertising on its platform. Notwithstanding, we believe that the impetus for Shopify to leverage advertising could be critical to help recover its margins, which could also be beneficial for its fulfillment buildout.
In addition, Amazon also launched its Buy with Prime program to leverage its fulfillment capacity to target Shopify’s DTC merchants. While the program is still in its early innings, we believe it represents a potent threat to Shopify. Even though the company will be focusing on first-party fulfillment, we don’t think Shopify can match Amazon’s fulfillment moat. Furthermore, given Amazon’s need to utilize its excess capacity, the competition could intensify on the fulfillment front moving forward. As a result, Shopify could potentially lose merchants to Amazon Prime checkout. As a result, it could further impinge on its ability to maintain its required high-growth cadence to justify its considerable growth premium.
Is SHOP Stock A Buy, Sell, Or Hold?
SHOP stock is still digesting the gains from 2020. As seen above, its upward momentum over the last two years was overturned by a massive bull trap in November 2021.
While the extent of the decline has been spectacular, it should not be surprising. As discussed earlier, investors should remember that SHOP stock still traded at a massive growth premium, with an NTM normalized P/E of 160.2x.
We also believe that Shopify’s execution risks have increased with Amazon’s recent Buy with Prime announcement. Furthermore, Amazon needs to leverage its excess capacity urgently to reverse its fixed costs deleverage. In addition, Meta is also increasingly pressured to improve its targeting and attribution due to Apple’s ATT framework. As a result, we believe the friction between Meta and Shopify will likely worsen moving forward.
Hence, we downgrade our rating on Shopify from Buy to Sell. We encourage investors to use any potential bounce from a positive Q1 print to sell into strength. There’s still about a 30% implied downside to its COVID bottom. Therefore, investors should wait for SHOP stock to potentially revisit its COVID lows before considering adding exposure.