Did Shopify Just Turn Things Around?

In November 2022, we rated Shopify (SHOP) a 3/10, much to most people’s surprise.

Since then, the stock has rebounded almost 50%, though much of that came from the latest earnings release.

And it’s that release that got us and many financial pros interested in the company.

What exactly changed?

Three words – free cash flow.

The company delivered $86 million in free cash flow for the quarter compared to burning $41 million in the same quarter last year.

Shares exploded on the news, climbing more than 40% in a matter of days.

So, is there anything left for those who took the wait-and-see approach?

Shopify’s Business

Chances are, if you shop online, you’ve come across Shopify.

It’s one of the fastest-growing e-commerce platforms in North America.

Customers, from individual entrepreneurs to large enterprises, can pick and choose from:

• A drag-and-drop store builder
• A payment processing system
• A shipping management system
• A marketing and advertising platform
• A customer support system

The company keeps prices fairly reasonable with subscriptions for as little as $5 per month.

Source: Shopify Investor Relations

Shopify’s easy-to-use platform makes it the choice of over 1 million businesses in over 185 countries.

Financials

Source: Stock Analysis

Sales have exploded since the company went public in 2015, increasing between 50%-100% every year.

However, margins from gross to operating got worse every year.

Investors were willing to look the other way until growth bega to slow in 2022.

Then it all became about profitability.

Thankfully, management took steps to improve their operations.

While the seasonality of the business generally leads to free-cash-flow in the back half of the year, the front half is tougher. And in 2022, the company failed to generate free cash flow as it had in the past.

In fact, free cash flow had been falling every quarter since the boom during the early part of the pandemic.

That’s what made the latest results so crucial. It showed the company could manage its business responsibly without sacrificing growth.

Valuation

Source: Seeking Alpha

Software application companies like Shopify, Uber (UBER), and Twilio (TWLO) typically aren’t profitable on a price-to-earnings basis given the heavy up-front spend.

Instead, investors look at the price-to-sales and price-to-cash flow ratios as indicators of health.

Unfortunately, Uber is the only one reporting positive operational cash flow save for Crowdstirke (CRWD). Exela technologies (XELA) only had one quarter of positive operating cash flow in the last eight, and Twillio…well things don’t look great there…

Growth

Source: Seeking Alpha

For these software companies, it’s all been about growth.

And not all of them look like they can maintain their pace with only UBER and CRWD forecasted to exceed 30% revenue growth next year.

That’s a major problem for all of them, Shopify included.

Profitability

Source: Seeking Alpha

Gross margins can vary wildly based on the software products themselves. So its best to try and compare them on either EBITDA or EBIT margin.

Unfortunately, only XELA has a positive EBITDA margin.

Everyone else is negative across the board.

Our Opinion 5/10

We upgraded our opinion but not by much. 

Shopify is doing the right things to make its business profitable.

What we don’t know is what it would look like, stripped down to its core. 

Are we talking about a net income margin of 10%, 20%, 2%? 

What would a mature Shopify business look like?

We don’t know. And we’re not that interested in overpaying to find out.

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