After a couple of years in test mode, Shopify (SHOP -5.74%) said it's ramping up investment in its Fulfillment Network through 2024. That increased spending will short-term hit but eventually expand Shopify's booming and highly profitable e-commerce platform. What does that mean for investors?
Well, it could mean a turnaround for a stock that has endured a wicked 62.3% price crash from all-time highs set back in mid-November. After the price correction, the stock currently trades for a much more reasonable 27 times trailing 12-month earnings as of this writing. That's not to say the stock is cheap, though. On the contrary, with a big ramp-up in Fulfillment Network spend that's coming, this is still very much a "grow first, profit later" stock, and that P/E ratio will rise again (more because of the earnings side of the equation).
Still, given Shopify's track record for meeting ambitious goals, this planned jump in investment could be great news for long-term shareholders looking for a turnaround.
Power to the little merchant
What is Shopify Fulfillment Network (SFN), anyway? It might sound like a fancy way of saying "order delivery," but this goes far beyond shipping boxes to a customer. Shopify's goal with this service is to help small merchants provide some of the same exceptional services that Amazon (AMZN -4.41%) shoppers have grown to expect. Shopify president Harley Finkelstein explained on the fourth-quarter 2021 earnings call that upcoming changes to the Fulfillment Network could help "deliver packages in two days or less to more than 90% of the U.S. population while minimizing the inventory investment for SFN merchants."
SFN is a game-changing feature for small merchants. E-commerce has the potential to put power back into the hands of small entrepreneurs and business owners, but logistics are hard without the massive scale that Amazon, big-box retailers, and others benefit from. Shopify wants to change that.
It's simple, at least in principle. A merchant bulk-ships inventory to Shopify warehouses located around the country. The merchant then sells via various Shopify channels (a website, social media, etc.). Shopify automatically picks inventory from the nearest warehouse and fulfills the order. The merchant does ongoing inventory management through a dashboard, which recommends what products to replenish and where.
Of course, the actual technology working behind the scenes to power SFN is no simple task (more on that in a minute). But if you're a small business owner with dreams of selling nationwide and beyond, the relative simplicity SFN offers could be a dream come true -- especially since Shopify itself is not a retailer and doesn't compete with the merchants utilizing its services (like Amazon does).
About the SFN price tag...
Like any good capital investment into new technology, SFN will require some cash to get rolling. After all, these warehouses packed with robotics and artificial intelligence-powered software aren't cheap. Since the warehousing and fulfillment project was announced a few years ago, the company has made only modest investments into it thus far. According to Shopify CFO Amy Shapero:
When we launched Shopify Fulfillment Network in mid-2019, we said that we expected to spend $1 billion over five years. Through 2021, about halfway through the original asset-light plan, we spent $117 million, which includes funding cash operating losses and a small amount of capex.
What does that mean? Shapero added that SFN spending will ramp up in 2022, and there will be $1 billion in capital expenditures (property and equipment) in 2023 and 2024. In other words, SFN is going from prototype to full-blown service. Capital expenditures were a mere $50.8 million in 2021, so this figure will balloon over the next three years. So much for that "asset light" software business model.
But here's the good news: Shopify is generating gobs of free cash flow (FCF) right now and has lots of liquidity on balance. FCF was $454 million in 2021 alone, and cash and short-term investments net of debt were nearly $6.9 billion at the end of the year. Shopify can afford to expand SFN and then some.
The expected run-up in capital expenses in the next few years is why I'm reluctant to say Shopify is "cheap" right now based on its price-to-earnings ratio of 27. Current earnings will be reduced by spending on SFN in the coming years.
But then again, this company shouldn't be underrated. Though revenue growth will moderate from the 57% increase in 2021, forward double-digit growth from a company that just hauled in $4.6 billion in sales is no joke. Shopify Fulfillment Network will be an exciting development to keep tabs on as Shopify continues to support entrepreneurship in a new era of e-commerce.