Shopify Inc.'s (SHOP, Financial) stock has fallen more than 75% this year, which is an alarming loss of market value for a company that continues to grow consistently. Concerns about an economic recession have caused many growth stocks to go out of favor among investors, which is the main reason for the disappointing performance of the stock in 2022.
The multinational e-commerce company helps small and medium-sized businesses build and grow their online operations by providing a suite of products and services required for success. This includes payment processing solutions, marketing, shipping and other customer engagement services.
Shopify thrived at the start of the pandemic in 2020 when specialty retailers were forced to close their doors to in-person customers. As a result of the mobility restrictions, e-commerce sales as a percentage of total retail sales increased dramatically in almost every major economy. Customers, however, are starting to return to brick-and-mortar locations on the back of easing restrictions. As a result, Shopify's business has also slowed.
Further, with recession fears and consumer budgets tightening, investors believe the company will suffer from a slowdown in online shopping in the coming quarters. Although it may face short-term challenges, there are many reasons why Shopify could grow exponentially in the long run.
Recent earnings did not impress Wall Street analysts
Shopify missed both earnings and revenue estimates for the second quarter despite reporting a 10% year-over-year increase in subscription solutions revenue. Management projected gross merchandise value to outperform the broader retail market in the second half of the year despite inflationary concerns as well, but none of this could make up for the decelerating revenue growth.
Soon after the earnings release, Piper Sandler downgraded the stock and cut its price target from $38 to $32. In a note to clients, the firm's analysts wrote:
"While the outlook held some positive nuggets, the quarterly results point to an e-commerce environment that continues to deteriorate. Ultimately, we see the balancing act of growth investments and efficiency targets as posing new execution risks – on top of navigating a normalization in ecom growth rates that we do not yet have visibility into stabilizing.”
The average price target assigned by Wall Street analysts to the stock now stands at $40.75, in complete contrast to over $100 just a few months ago. Shopify's second-quarter earnings did little to impress analysts as well, and a series of downgrades have dampened investor sentiment toward the company.
Shopify benefits from three growth drivers
When the going gets tough and the short-term outlook for a company or the economy looks bleak, it is difficult for investors to keep their focus on the long run. However, short-term macroeconomic developments do not often have a permanent impact on the profitability of companies. In the long run, earnings dictate over stock market performance, though many external factors could impact share prices in the short run.
Shopify has a few difficult quarters ahead, but investors should not let these short-term challenges cloud their judgment of what the future holds for this high-growth business as it has three catalysts moving forward.
Innovative products and services to serve SMEs
The company's target market, small and medium-sized enterprises, is its single most important growth driver. According to the World Bank, SMEs are vital to job creation and economic development as they account for approximately 90% of businesses around the world and more than 50% of global employment. The number of SMEs has more than doubled in the past decade as many people continue to embrace entrepreneurship. However, access to finance remains a major impediment to the growth of small businesses. As a result of this barrier, they constantly fail to provide comparable services to larger players.
Shopify is an important player in this market. In the second quarter, the company funded $416.4 million in loans for its merchants. With the right amount of funding, SMEs can easily eclipse the growth of their larger peers, in which case Shopify stands to benefit as one of the leading facilitators of this growth story. The company is aggressively introducing innovative products to build long-lasting relationships with its customers, which could help it enjoy competitive advantages in the future.
The fast-growing creator economy
Alphabet Inc.'s (GOOG, Financial) YouTube recently announced a partnership with Shopify to allow creators and merchants to feature their products on available channels. The products will be displayed during live streams or at the end of videos. They will also take advantage of Shopify's real-time inventory syncing so viewers can see if something is out of stock in real time. Creators in the U.S. can also enable onsite checkout, which allows their viewers to complete their purchases without leaving the platform.
This collaboration will boost growth because an increasing number of SMEs are leveraging social media platforms, and YouTube is at the top of the list with over 2 billion monthly users. Previously, the company teamed up with other social media platforms such as TikTok, Facebook and Instagram, which quadrupled the number of orders placed through partner integrations.
The secular growth of the e-commerce industry
E-commerce spending as a percentage of total retail spending has dramatically increased since 2020. Despite the short-term volatility, it is reasonable to believe the percentage of online spending will continue to rise over the next five years. According to the International Trade Administration, global e-commerce sales are expected to reach $6.4 trillion in 2024, or 22% of all retail sales worldwide, up from only 18% in 2020. This suggests Shopify still has a long way to go in capturing market share.
The convenience of online shopping will continue to drive more businesses and consumers to online channels. While it was previously difficult and time-consuming for small businesses to establish an online presence, Shopify has alleviated the majority of their concerns. The company is expanding rapidly and has established itself as a reliable source for a growing number of SMEs looking to take their products online.
Shopify assists merchants in not only creating a business-oriented website, but also in managing transactions and payments, shipping and handling and short-term funding. The company recently announced the $2.1 billion acquisition of Deliverr, a logistics company that will help its merchants improve their fulfillment services.
Takeaway
Although e-commerce sales are poised to slow down in the coming quarters, the long-term opportunity in this sector remains very appealing.
Management confirmed revenue will likely take a hit in the short run, but e-commerce spending will eventually recover with the growing adoption of digitalization, allowing Shopify to thrive in the long run. Growth investors with an extensive investment time horizon, therefore, are likely to find the stock attractively valued today.
