Shopify (NYSE: SHOP) makes smart decisions to prioritize its long-term profits and reputation over short-term returns. The acquisition of Deliverr allows the company to improve its supply chain and launch Shop Promise. This program will give merchants access to 1-2 day shipping and verification badges to ensure reliability and improve business reputation. This, along with the fading tailwinds from the pandemic, will likely cause the business to struggle in future periods due to rising costs and falling demand. On the other hand, the rise of freelancing will help offset these costs as it will likely lead to more subscriptions and transactions in Shopify stores. However, the stock still looks set to continue falling, which means investors may want to wait before jumping in.
Shopify focuses on the long term at the expense of the short term
In one of my previous Shopify articles, I explained why I think the company prioritizes long-term profits over short-term returns. While this is great for long-term investors, it also means the stock will continue to decline over the next few periods.
The first way Shopify prioritizes long-term profits is by acquiring Delivery man. Deliverr will help improve the Shopify distribution network and provide merchants with access to a simpler and more efficient supply chain. Deliverr is a competitor to Amazon Prime (AMZN) by allowing merchants to deliver 1-2 days shipping and further solidifies Shopify as a strong e-commerce brand. Deliverr is able to deliver on these promises by renting warehouses across the United States and supplying them with popular items sold in each region. This will allow Shopify merchants to provide better service to their customers, improving the long-term health and reputation of the business. However, these logistical changes will also be costly in the short term and could cause the company’s margins to squeeze in future periods.
The acquisition of Deliverr also enables the company to launch Shop Promise. Shop Promise is a new service that allows merchants using the Shopify Fulfillment Network or Deliverr to offer next day or two-day shipping. Additionally, the service allows trusted merchants to display a verification badge similar to social media sites. This assures customers that the merchant is reliable, solving a major problem with many e-commerce sites. Again, this helps improve Shopify’s long-term reputation but greatly increases short-term logistics costs.
Rise of self-employment could help offset higher costs
Although Shopify will likely face higher costs and drop in demand for e-commerce due to the near-term waning of the pandemic, a possible coming recession could lead to more freelancers becoming merchants through Shopify. With inflation on the rise, interest rates rising and purchases of less expensive items, many analysts and investors are project a recession will probably happen in the near future. However, all of this may not be bad for Shopify’s business.
In times of recession, unemployment rises dramatically. During the Great Recession, unemployment peaked at 10%. More recently, unemployment sharp at 14.8%. With workers losing their jobs and in need of a source of income, many turn to freelancing and therefore open an e-commerce store. In 2020, the number of full-time freelancers increased by 8% and part-time freelancers increased by 4%. On the other hand, people who did parallel self-employment fell by 11%. With freelance work becoming the full-time job of many workers, Shopify stores will devote more time to it. This will result in higher quality stores, better products and a better reputation for the business in the short and long term.
Along with the increase in the number of freelancers in 2020 and other recessions, it is also expected to increase steadily over time. From 2021 to 2028, the number of freelancers in the United States is expected to grow at a CAGR of 4.2%. This means that the total number of freelancers in 2028 could reach 90.1 million. This would provide Shopify with more merchants using its services and lead the company to achieve higher fundamentals in the short and long term.
Along with the increase in the supply of freelancers, the demand increases with it. During a recession, many companies reduce their workforce to cut costs. Although these companies are laying off employees, they still need their plans to materialize. This leads them to turn to independents because of their affordability to work fewer hours and not receive benefits. This would benefit Shopify as its merchants would see more orders and larger purchase amounts from businesses than normal consumers, allowing Shopify’s fundamentals to improve.
The rise of freelancers during a possible recession would benefit both Shopify’s revenue streams through more merchant signups and higher transaction volumes. The company’s subscription solutions revenue would see improvements thanks to the increase in the number of merchants register for the service. This would directly lead to the improvement of the company’s turnover in the short term. However, only 29% of the company’s total revenue is generated from subscriptions. The remaining 71% is generated by the Merchant solutions segment and that becomes the real winner for the company. This segment generates revenue through transaction fees and the use of Shopify’s services to fulfill orders. Therefore, higher trading volumes would result in much higher revenue. As stated earlier, the supply and demand for freelancers increases during a recession. With the likelihood of a recession coming soon, Shopify’s future volumes will likely increase and drive even higher revenue for the Merchant Solutions segment.
To find the value of Shopify stock, I created a relative valuation for the company. Combining FY23 analyst consensus estimates with the average EV/Revenue and P/S valuation multiples of Shopify and its competitors, a fair value of $26.16 can be calculated after adjusting for net debt. . This implies a drop of 20.65%.
However, it is important to note that the entire e-commerce industry has been falling recently due to the tailwinds of the pandemic fading and in-store shopping returning. Therefore, the average valuation multiples of Shopify’s competitors will likely continue to decline and drive its projected fair value down with it. Therefore, I think investors should start considering jumping into the stock in the $25-$30 range.
What does this mean for investors?
Shopify is making strides to improve the long-term health of the business and improve its reputation with consumers. The acquisition of Deliverr and the launch of Shop Promise will help improve the supply chain for merchants in the long term, but it will likely lead to significantly higher costs in the short term as management adjusts the company’s logistics . These higher costs could be partially offset by the growing popularity of freelancing, especially during a possible recession. Although e-commerce is struggling due to the return of in-store purchases, the growing likelihood of an upcoming recession could lead to increased subscription and transaction volumes for Shopify. This would directly benefit both revenue segments of the business and help protect it against economic downturns. However, the stock still appears to be slightly pricey and will likely drop further due to short-term plans. Because of all of this, I’ll apply a Hold rating for now.