Shopify Stock: Strong Plus Migration Is A Bullish Signal (NYSE:SHOP)

We Are Investment Thesis Shopify’s (NYSE:SHOP) has dropped 20% over the past month after a strong 1Q FY2024 earnings. This selloff was largely due to a weak forward guidance, even though revenue and EPS beat expectations in the last quarter. Unsurprisingly, the stock’s premium valuation indicated high expectations going into the quarter, making it vulnerable to a weak forward guidance. In my previous analysis, I initiated a neutral rating on the stock and raised concerns that a valuation of over 10x EV/Sales FWD could pose a significant downside risk if top-line growth disappoints investors. The stock is currently trading flat despite a significant “U” turn over the past 7 months, which has largely underperformed compared to the 20% rally in the S&P 500 index. I believe the recent selloff is overdone and the stock at this level presents an attractive entry point. The company’s key growth drivers remain on track, and its current heavy spending on marketing is expected to improve the growth outlook in the mid-term. Therefore, I have upgraded the stock to a buy rating. Shopify Pricing Structure Shopify Let’s talk about the pricing changes first. Back in February, Shopify Plus was expected to increase its monthly price by 25%, from $2,000/month to $2,500/month for existing customers. However, existing customers can lock in the current $2,000/month rate if they renew with a 3-year contract (until CY2027) by the end of April 2024. In comparison, new customers will pay $2,300/month. Meanwhile, the company also increased the online variable platform fee for customers on annual contract terms. I believe the timing of this renewal will have a meaningful impact on financials. In the 1Q FY2024 earnings call, the management reported continued enterprise migration and explained that the majority of Plus merchants have migrated to 3-year contracts to lock in the $2,000/month rate. This would increase overall contract duration and stabilize billing trends in the near term. However, they also mentioned that in Q2, the lapping effect of the Standard plan changes will outweigh the initial benefits of the Plus pricing changes, resulting in a headwind to revenue growth on a quarter-over-quarter basis. Nevertheless, despite a muted revenue outlook, SHOP’s underlying demand remains strong. Resilient Consumer Spending The company model While the company lowered the revenue guidance from “low to mid-twenties” growth to “high-teens growth” for 2Q FY2024, this is largely due to a 3%-4% growth headwind from the sale of logistics businesses and the near-term dynamics of pricing changes. Excluding this factor, the company would continue to maintain a +20% growth trajectory in revenue for the current quarter. I think investors might have overreacted to the guidance because we have noticed that SHOP’s MRR has shown significant acceleration in growth since 2Q FY2023. In the last quarter, the company grew 30.2% YoY to $151 million, demonstrating that consumer spending momentum remains healthy. The company model In addition, we can see that SHOP has significantly boosted GPV and GMV growth starting from 3Q FY2022, indicating a continued strength in same-store sales growth and merchant base. Particularly, GPV continued to accelerate to 31.7% YoY compared to 31.6% YoY in the previous quarter. The growth rate is significantly higher than PayPal’s (PYPL) low-teen digit growth trajectory and Block’s (SQ) high-single digit growth over the past quarters. Therefore, I believe that SHOP’s key growth drivers are still robust as a result of ongoing Shopify Plus migrations along with strong returns on marketing investments. Elevated Marketing Spendings The company model The management also indicated that operating expenses are expected to grow by low to mid-single digits QoQ for the current quarter, primarily due to increased marketing costs. Looking at the chart, we notice that the marketing expense as a percentage of total revenue has increased significantly from 14.8% to 19.4% in 1Q FY2024, the highest it has been over the past 5 quarters. However, the management emphasized the importance of marketing spending, highlighting the utilization of advanced AI and machine learning models by the marketing teams to target audiences with unprecedented precision. During the earnings call, they noted that new merchant acquisition grew by 180%, and CAC improved by nearly 60%, comparing Q3 2022 to Q1 2024. Management plans to maintain marketing spending with an average 18-month payback period, which I believe is a potential upside catalyst that investors should monitor in the upcoming earnings calls. While near-term elevated operating expenses may impact profitability, it is likely that these investments will soon pay off, driving revenue growth and improving margins in the mid to long term. Valuation Seeking Alpha After a 20% post-earnings selloff, I admit that SHOP is still trading at a premium valuation, with an EV/Sales TTM of 10x. However, if we consider the company’s revenue growth FTM, this multiple is expected to decrease to 8.5x, which is 16% lower than 10.1x since my last coverage. As I previously mentioned, a ratio exceeding 10x is considered lofty and potentially unsustainable. JPMorgan In order to gauge its fair value, we also need to factor in its revenue growth trajectory, as high growth stocks deserve higher valuation multiples. If a company is trading at 20x EV/Sales FTM, its revenue growth is expected to maintain over 30% in the next 5 years. I think it’s fairly valued. Considering SHOP’s forward revenue growth of 22.4% based on Seeking Alpha, SHOP’s EV/Sales/g ratio stands at 0.38, nearly 50% lower than the large-cap software average of 0.71x, as indicated by the chart (prices may lag by a week). Therefore, I believe the stock is becoming more attractive at its current level, as its underlying merchant growth and consumer spending remain resilient, potentially supporting a higher multiple compared to peers. Furthermore, with market consensus expecting declining interest rates later this year, I believe this will create a valuation tailwind for high-multiple stocks like SHOP. My expectation is that the Fed policy is currently very restrictive, keeping rates at 5.25%. However, with the unemployment rate unexpectedly increasing to 4%, maintaining higher rates for longer increases the likelihood of more significant rate cuts in the future. Despite a valuation tailwind, investors should be mindful of a downside risk to the company’s fundamentals. A series of rate cuts may indicate severe economic deterioration, which would negatively impact overall consumption and, consequently, SHOP’s growth outlook. Conclusion In conclusion, I admit that SHOP has faced significant selloff following the recent 1Q earnings. Despite this, the company’s fundamentals remain robust, with revenue and EPS consistently exceeding estimates. While concerns persist regarding its premium valuation and the impact of pricing changes on near-term growth, SHOP’s strategic initiatives, such as using AI in marketing and attracting new merchants, show many potential growth opportunities. Moreover, despite the current elevated operating spendings in marketing impacting the bottom line, I believe the payback will create a revenue growth tailwind for the company. Therefore, I am upgrading the stock to a buy rating as a 20% drawdown in one month is overdone, considering the underlying robust growth metrics.

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