Shopify NYSE: SHOP stock rose 17% in early trading on better-than-expected earnings. Management outlined that the company is set to get back on track after a couple of weak quarters, where sales came in far lower than expected. Shopify’s management had previously stated that investment into its product mix was had resulted in lower-than-expected profits. Investments were important to get the company back on track to growth.
Shopify’s Investments Paying Off
Monthly recurring revenue increased by 8% to 107% as Shopify Plus merchants and retail locations used the point-of-sale (POS) service to drive monthly recurring revenue (MRR). MRR for Shopify Plus was 33% compared to 28% in the same quarter of 2021. Shopify has continued to target entrepreneurs or startup businesses, then looks to convert them to Plus merchants in the future by offering a range of services that can help their businesses get into small- and medium-business territory.
Shopify had double-digit growth in gross merchandise value, which increased 11% for the quarter. Gross payment value increased from 49% of total gross merchandise value (GMV) to 54% of GMV year-over-year (YOY), as new merchant adoption in the U.S. and internationally drove revenue, helping to improve profitability due to a better mix. Merchant solutions grew by 26% and Shopify has been increasingly investing in this service as it looks to improve synergy between its merchandise sales and payments. Merchant solutions tend to have lower margins, which leads to gross profit increasing by 9% to $681 million, lower than the top line, which increased by 22%.
Operating losses continue to be a factor. The current quarter witnessed a $45 million loss compared to a $120 million profit in the same quarter in 2021. The lack of profitability can be attributed to lower margin product mix and increasing costs. These costs largely stem from sales and marketing and R&D, both of which make up a significant portion of Shopify’s operating costs.
Tailwinds from Small Businesses
Small business optimism has continued to improve in October despite current economic conditions, marking three months of continued improvement. Inflation continues to be the hottest topic for small businesses but the number of small businesses that will increase prices (or plan to) declined to 51% over the last month, according to the National Federation of Independent Businesses.
Shopify has also started to bring on a number of large merchants, including Cole Haan and Panasonic, along with already established players such as Gymshark. Shopify also continues to partner with a range of tech companies such as Pinterest NYSE: PINS and integrates partners such as Stripe and PayPal NASDAQ: PYPL onto its platform in order to better serve customers. By integrating these partners onto its platform, the company has allowed itself to attract higher-margin clients who already have an established sales network. This could help get margins back to previous levels and the company back to profitability sooner than investors expect.
International markets remain key to Shopify’s growth if the e-commerce giant maintains its growth rate. Shopify continued to improve its international presence during the quarter by allowing merchants to sell products across borders and by offering a range of logistics, currency and marketing solutions, leading to Shopify Markets adding 175,000 merchants to its platform during recent months.
Shopify Capital provides advances to merchants and small businesses should also see significant growth across global markets. Since the Dodd-Frank Act, many small businesses remain underserved in terms of working capital, which provides an opportunity for Shopify to fill in the gap that banks usually fill. As small businesses continue to seek capital in a tightening environment, Shopify Capital took advantage of circumstances and total loans grew by 29% YOY to $509 million for the third quarter.
Shopify’s stock is down close to 80% from its 52-week high and currently trades at around 7x sales, making it still relatively expensive. Historically, stocks whose projected rate of growth was around 20% to 25%, could expect a 5x valuation. A lack of profitability will make investors cautious despite the rally after earnings. As the product mix brings gross margins lower, the bottom line in the long term could also be lower than other tech companies. Unlike competitors such as Amazon NASDAQ: AMZN, Shopify doesn’t have high levels of capital expenditure, with average capital expenditure ranging around $45 million.
Shopify will continue to concentrate on global expansion and improved cross-selling as it looks to bring more merchants from the entrepreneur and basic services levels to SMB and Plus levels. Shopify concentrates both on expanding globally and providing better tools so its merchants can continue to make that jump. For now, expansion plans are working out but investors will look for Shopify to become profitable. Long-term profitability could be around 20%, considering its current gross margins. For now, management is concentrating on expanding both services and global penetration.
Overall, Shopify is trying to establish itself as a premium e-commerce company, which provides end-to-end service. It remains to be seen if the strategy will pay off compared to competitors such as WooCommerce and BigCommerce, which have taken a much more targeted approach to merchants.
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