Shopify (SHOP 2.63%) is one of the top-performing stocks of the last few years, with shares up 150% in the last 12 months alone. The rise of small businesses going online has fueled the growth of Shopify and other e-commerce platforms, with the industry also supercharged by the dynamics of the pandemic.
Another market-leading company powering many of these e-commerce businesses is Avalara (AVLR +0.00%). Here's why investors should take a look at the stock.
The product applies to all businesses
All businesses, whether they sell online or in-person, have to file taxes with their state and the IRS. When selling in person, this can be somewhat simple. But once you move online, the hundreds of different laws and tax rates that apply (especially if you sell internationally) make the tax process exponentially harder. This is where Avalara steps in.
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Avalara's flagship AvaTax product automates tax compliance for e-commerce companies that have to deal with the hundreds or even thousands of different taxable events that can occur when selling online, especially if you have a global presence. The company sells its software through a subscription but also on a volume-based model. This allows it to scale with the businesses it serves, like Twilio does with its communication application programming interfaces (APIs) for the businesses it serves.
While its bread and butter is e-commerce compliance, Avalara also offers solutions for manufacturing and accounting businesses. In all likelihood, its long-term goal is to serve businesses of all types.
Lastly, the company also offers solutions for tax returns and business licenses, providing a comprehensive service for its customers.
The key is integrations
A big part of Avalara's value proposition is the ability to use its software on other e-commerce platforms. Clients who sell on platforms like Shopify, Wix.com, and Etsy can use Avalara's software while staying in the same ecosystem. While these plug-ins likely lower Avalara's margin by sharing some revenue with these other businesses, they act as a free marketing tool to potentially get Avalara's products into the hands of thousands or even hundreds of thousands of new customers. Churn is notoriously high with small-business solutions due to higher rates of bankruptcy. But since Avalara's offerings are needed for every business every year, the company actually has a churn rate under 4%, according to management.
Valuation and financials
With a market cap of $10.7 billion and $500 million in 2020 revenue, Avalara trades at a price-to-sales ratio (P/S) of 21.4. This is high relative to even its software peers. But with gross margins above 70%, a quasi-recurring revenue model, and low churn rate, it is understandable that Avalara trades at a premium valuation.
Management guided for 25% sales growth in 2021, which will help the valuation come down a bit. Avalara also posted a 107% net revenue retention rate in 2020 (which correlates to 7% sales growth from existing customers), showing that even in a turbulent year like 2020, the use cases for its products continue to grow.
Another reason not to get scared by the valuation is the gigantic market opportunity that Avalara is going after. According to management at its investor day last summer, there are over a million potential customers just in the United States that could use Avalara, with most still unaware that its solutions exist. With less than 15,000 customers at year-end, that is a lot of white space to go after.
Avalara is an industry leader with a strong customer value proposition in a rapidly growing market: e-commerce for small businesses and individuals. This combination makes it a compelling investment opportunity and should put it on any savvy investor's radar. At such a steep valuation, however, investors should also understand that in order to get good returns, the company will need to grow its business at a high rate for the foreseeable future.
