On the back of exceptionally strong second-quarter results, Shopify (NYSE:SHOP) surpassed $1,000 a share for the first time in July. The COVID-19 pandemic accelerated the shift that was already under way toward consumers doing an ever-greater share of their shopping online, and the turnkey e-commerce platform has benefited hugely.
After topping out around $1,146 a share at the start of the month, the stock price has pulled back during September by nearly $200 a share, in line with a decline in the broader market.
After that drop-off, is Shopify stock a steal?
Digital turnkey shops swell on a wave of closures
As the coronavirus pandemic forced states and countries to impose various degrees of lockdowns on their citizens and businesses in the second quarter, Shopify saw a 71% quarter-to-quarter jump in new store creation. The intuitive digital storefronts that the company provides offered a vital avenue of business for small and medium-sized companies that were obliged to close their physical locations. That need, along with its temporarily extended 90-day free trial offer, drove to a huge influx of new clients to Shopify.
Businesses that had previously been on the fence about going digital were practically forced to resort to online shops or go out of business, and Shopify made it nearly painless for them.
Users of these free-trial merchant accounts were expected to continue converting them to paid subscriptions through the end of August, but the company acknowledges that its conversion rate for those free accounts is slightly lower than it was before the pandemic. On the other hand, a large number of merchants upgraded to the premium, $2,000-per-month Shopify Plus plan, outstripping the number that downgraded to cheaper, more basic plans, which indicates that the revenue-earning quality of merchant additions has increased.
But what happens after?
The strength of new shop creation and plan conversion on Shopify's platform contributed to a 97% year-over-year increase in total revenue and a record jump from a 2019 second-quarter net loss of $28 million to a 2020 second-quarter net profit of $36 million. But the company has elected not to offer financial guidance for the rest of 2020, citing economic uncertainty and the rising possibility of an "extended global recession."
Moreover, the question arises: As more and more businesses are able to reopen their brick-and-mortar locations, will Shopify be able to sustain its growth trend?
There are three major scenarios that could unroll:
- A majority of new Shopify digital stores are closed as the companies that launched them return to being strictly in-store businesses.
- These businesses appreciate the second revenue stream and maintain both in-person and digital stores.
- Significant numbers of physical businesses don't recover to their pre-pandemic levels, leading their proprietors to shutter the brick-and-mortar operations and migrate fully online.
The first potential case bucks the growing e-commerce trend, and belies Shopify's experience of new clients converting to paid merchant accounts, so it seems unlikely. The second appears to have a higher possibility of coming to pass, so long as consumer spending bounces back to pre-pandemic levels despite peoples' economic and health concerns. If consumption levels fall, though, many hard-hit physical shops may eventually have to resort to option three in order to save on fixed costs and stay afloat.
Of course, there is an unlikely fourth scenario that could arise: large numbers of businesses that tried to stay afloat with the help of a Shopify store fail completely. Shopify would thus lose a significant amount of its recent gains in its client base.
However, in this case, Shopify might not be as hard hit as one would think. The company has historically high churn rates for first-time merchants, and absorbing the cost of a large number of failed digital shops should not be unusual or difficult so long as the few, robust survivors contribute a sufficient amount to offset it. In fact, as stated above, Shopify has already seen a lower conversion rate for these pandemic-fueled merchant additions, but the company's revenue train is still running strong.
As such, Shopify's growth may slow in the coming quarters as customers return to in-person shopping, but the likelihood of a trend reversal is low. The shift toward e-commerce is still going strong, with expectations from a Grand View Research study in May suggesting that the global e-commerce market will double by 2027 to $27.15 trillion in value.
At the moment, Shopify is trading down about 16.8% from its stratospheric highs, and this year's results may reflect the challenging landscape that many businesses are facing. But over the long term, more and more shops will eventually move online, and many of them may choose Shopify's easy-to-use interface. The long-term shift in shopping habits could ultimately push this growth stock even higher, so buying the dip may not be such a bad idea after all.