After an Impressive 2016, What Lies Ahead for Shopify Inc?

In this segment from Market Foolery, Mac Greer, David Kretzmann, and Jason Moser talk Shopify (SHOP -2.37%), a fast-growing company you many not know by name, but one you have probably interacted with if you do any shopping online. Its sales were up 86% year-over-year, and the team explains why there is reason to believe that growth at these impressive rates could continue for quite some time -- or even accelerate.

A full transcript follows the video.

This podcast was recorded on Feb. 15, 2017.

Mac Greer: Shares of the e-commerce platform up big on Wednesday after the company reported better than expected earnings [the stock has gained 12% since the release]. David, I think for a lot of investors, Shopify is not exactly a household name. The stock has really been on a tear, though.

David Kretzmann: Yeah, Shopify is a company that's in the background, but you've probably interacted with its platform in some shape or form. The company serves almost 400,000 merchants, mainly small and mid-size businesses. So, if you're a small business looking to get online and have an online shopping cart, Shopify is one of the platforms to go to if you're looking to set up a shopping cart, set up that online platform to offer goods and services online. A lot of smaller businesses are among Shopify's customer base. This was a great quarter. The company is having no problem growing quickly right now. Sales were up 86%, they added 50,000 merchants, bringing that total to 375,000 merchants under their umbrella. That's up more than 50% from where they were at the end of 2015.

So, a lot of growth here. And the market opportunity here is still pretty big, and I think that's why, even though the stock is trading at a premium valuation, this level of growth theoretically could continue for a while. If you look at the key geographies where Shopify operates today, there are about 10 million merchants with less than 500 employees in those markets. That's really the key demographic that Shopify is going after. And every time, the average revenue per merchant on Shopify's platform is above $1,200 now. That would suggest a market size of about $10 billion. So, still a lot of room to run here, but the stock is still pricey.

Jason Moser: Yeah. We've looked at Shopify for MDP, it's obviously a recommendation in a number of our services here. A very fascinating business from a number of different perspectives. There are a couple of things, questions I still need answers to here. No. 1 is just from the profitability perspective. They are growing, still not profitable, not cash flow positive. I wonder when is all of that going to change? Because I think if it does change, when it does change, it could be a tremendous catalyst, but I also wonder how much the market is pricing into there today.

But the other question I have is just in regard to third-party relationships. With everything that Shopify does well, there is a provider that's helping them along the way. And I'll use payments as an example. They contract with Stripe, I believe, as a provider on the payment side. At some point, Stripe is going to look to become profitable, and they're going to try to exercise a little pricing power, which, in turn, is going to flow through Shopify's financials, unless they figure out a way to diversify from that provider as well. So, I just wonder, from the perspective of those third-party providers, how that plays out on this business down the road, and its profitability.

Greer: And along those lines, they've also got one of those frenemy dynamics with Amazon. They compete with Amazon, but they're obviously a partner of Amazon's. So, David, when you think about that frenemy dynamic, as a potential investor in Shopify, how much should that concern you?

Kretzmann: I think it's something to be aware of. I think some people gave Shopify a little bit more credit than it deserves for the transition Amazon made from its web store business. In 2010, Amazon launched a similar business to what Shopify has done. It was a few years after Shopify had started, and Amazon essentially said, "We have a lot of third-party sellers on Amazon and we want to build a web store for those sellers to have their own independent website," which is essentially what Shopify did. Amazon shut that down in 2016 and basically made it easy for those Amazon webstore sellers to transition or migrate to Shopify's platform. So, Shopify called itself the preferred migration partner. But what a lot of people don't say is that there were only about 1,000 merchants on Amazon's platform last year. So, it's a win for Shopify, but it's not a huge catalyst, I don't think.

You want to be aware of all those dynamics. To a similar point, it's not just with Amazon, it's also with those third-party merchants, the payments providers, the shipping solutions, because you have a lot of different companies providing those services. You have other online marketplaces like Etsy, which are branching more and more into Shopify's territory. So, I can see why people are excited about the business, because on the surface, this is a potentially very attractive business, because it's recurring revenue, it's a subscription fee, Shopify is bringing in monthly subscription revenue. If they can retain those enterprises over time, that could be very profitable. But up to this point, the company's losses are expanding, still burning cash. It's a riskier stock, still.