Shopify's Flying High - Will earnings shoot it down?

Plenty of growth stocks are being tested in the current market environment. Lyft’s share price was decimated after their earnings call and closed last week 40% lower. An extreme example, but market patience is running thin with some of these companies. Grow & increase profits or get punished. Shopify’s under the spotlight next week awaiting investor judgement.

First, some context. From peak to trough, Shopify shares fell by ~86%. That was a serious revaluation of the company's prospects. The discount was too deep to pass up. Buyers stepped in at the lows and pushed the valuation a little higher.

The price to sales ratio has fallen from an eye-watering 61.2 (February 23rd 2021) to 9.97 (February 10th 2023). On that metric, some might say that Shopify’s valuation is far more reasonable. As always, it depends.

If sales decelerate and the share price stays static, that ratio ticks higher. To some, that would indicate shares in the company becoming more expensive. However, investors are willing to pay all kinds of multiples based on different views, points in cycles, time horizons, and so on. Precisely defining cheap/expensive is always a tough task.

So, let’s look at the facts and earnings expectations ahead of Wednesday's (15th February) release:

Shopify Inc has a market cap of approx. $62.5bln

• Exp. Quarterly EPS: $-0.01
• Exp. Quarterly Revenue: $1.65bln
• Exp. FY EPS: $-0.05
• Exp. FY Revenue: $5.51bln

A few big picture themes are bubbling ahead of the earnings release. The most obvious is the health of the global consumer. While the economy has clearly slowed, analysts and commentators are pointing out the potential of soft landings, or even no landing for the global economy. Recession avoided.

Given the uncertainty and mixed messages in the data, it seems foolish to become overconfident. Do Shopify see signs of a reduction in overall spending? Are Shopify merchants able to grab a larger share of global sales than they have previously?

On a more micro level, how are the merchants responding to changes in Shopify pricing? The company announced significant price hikes on the Basic, Shopify and Advanced monthly plans, although the price hikes could be avoided if merchants opted for annual plans instead.

A savvy move to lock merchants in for longer and ride out any storm ahead?The pricing change could also see a slight boost to revenues in the present at the expense of the future.

In the end, the earnings call could be more consequential than the actual results. What’s the story Shopify is telling? Most importantly, is there a plausible path towards profitability?

At the start of 2023, Michael Cembalest, a 37 year market veteran and Chairman of Market and Investment Strategy for J.P. Morgan Asset Management drew parallels to the dot-com period:

“It’s time to start thinking about whether unprofitable companies like Peloton, Carvana, Shopify, DoorDash, Spotify, Roku and Roblox can become profitable or not.”

The evolution of the market is clear. The era of easy money that allowed YUC’s (Young, Unprofitable Companies) to flourish seems increasingly like a distant memory.

“Many unprofitable companies are in that position since the market did not require them to be profitable. With the benefit of ample pre- and post-IPO capital, they forged ahead with enormous customer acquisition costs in an effort to gain scale”

“Many cannot do that anymore, but some will figure out how to become profitable in this new era. The aftermath of the 2000-2002 dot-com crash is interesting in this regard”

“The below chart shows performance of tech companies from 2000 to 2004 based on their initial and subsequent profitability. Companies that remained unprofitable continued to languish. __However, unprofitable companies that became profitable by 2004 rallied sharply, catching up to companies that had been profitable all along.__”

Can Shopify make the grade or will market patience expire? The clock is ticking…