Shopify (SHOP -2.37%) stock is down a whopping 77.5% year to date and is one of the most visible victims of the 2022 bear market -- outpacing the Nasdaq Composite's decline of 33.8% for the same period. While most e-commerce companies face challenges like high inflation and shifting consumer behavior, Shopify looks particularly vulnerable. Let's explore why.
The post-pandemic slowdown
Like many e-commerce companies, Shopify enjoyed a surge of growth at the height of the COVID-19 pandemic when lockdowns and movement restrictions boosted interest in online shopping. The company's revenue surged 86% in 2020 and 57% in 2021. But now that the pandemic lift is fading, it faces difficult comps and declining profitability.
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Third-quarter earnings were a mixed bag. Shopify's revenue increased 22% year over year to $1.4 billion, which isn't bad considering how strong its performance was in 2021. Most of the sales growth came from the company's core merchant solutions segment, which helps small businesses create and manage storefronts (both online and in-person) through tools like its payment processor, Shopify Payments.
Sustainable profits look far away
Shopify is still far from sustainable profitability, with a third-quarter net loss of $158.4 million, down from a net income of $1.15 billion in the prior-year period. According to CEO Harley Finkelstein, management "overshot" its growth predictions, which may have led Shopify to over-expand in anticipation of revenue that didn't materialize. Overexpansion leads to lower margins and lower profits. To rectify the issue, Shopify embarked on some high-profile cost-cutting measures.
In July, Shopify announced plans to lay off roughly 10% of its global workforce (1,000 people). These efforts are yet to show up in its operating results. In the third quarter, general and administrative expenses surged 98% year over year to $255.13 million. Research and development and sales and marketing outflows jumped 87% and 27%, respectively. These trends suggest Shopify may be working harder to attract customer interest and keep its products relevant against increasing competition.
Shopify's moat is weakening
The term "economic moat" refers to a company's ability to differentiate itself from rivals and protect its market share. For Shopify, this will become more difficult because of encroachment from rivals such as e-commerce giant Amazon (AMZN -1.65%). Amazon has long been a threat to Shopify's stomping grounds because it also has a suite of merchant solutions like Fulfillment by Amazon, which allows clients to outsource their shipping and warehousing needs.
The e-commerce giant is taking a step further with a new service called Buy with Prime (launched in April). This solution allows partnered merchants to use Prime perks like free delivery and seamless checkout on their stores -- an even greater threat to Shopify's niche. It is unclear how Shopify can maintain high growth rates in the face of tougher competition while preventing its losses from spiraling out of control.
Management may be forced to rely on profit margin-eroding marketing and research & development spending to stay relevant in the industry.
The stock isn't that cheap
With its steep declines, Shopify may have caught the attention of value-hungry investors, but the stock isn't as cheap as it looks on the surface. With a price-to-sales multiple of 7.8, shares are valued significantly higher than the Nasdaq average of 5.1. The stock is also much more expensive than Amazon, which trades for just 1.9 times sales.
Shopify's high top-line multiple doesn't look justified because of its slowing growth, growing competition, and unclear pathway to profitability. The stock could face continued downward pressure.
