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Stocks  | October 15, 2019

In 2019, investors in one of Canada’s best tech names, Shopify (NYSE:SHOP), has enjoyed great returns. SHOP stock is up over 155%. So far Ottawa-based SHOP stock has been a high-growth company. Through its multi-channel commerce platform, merchants can set up online storefronts with retail functionality.

Many analysts have been concerned about the high valuation of the stock throughout the year. However, the Shopify stock price has kept going up. On Aug. 27, SHOP stock reached an all-time high of $409.61. Now it is hovering around $330.

With the recent drop investors are wondering if the share price can once again start to rise in the coming months. SHOP stock is expected to report earnings on Oct. 29. Let’s look at what may be next for the share price.

Shopify Stock’s Story So Far

Shopify stock has been a darling of Wall Street since its IPO in May 2015. It started trading at a price of $28. And it has become one of the most watched tech stocks.

Quarter after quarter, the stock has been gaining impressive market share in the rapidly growing e-commerce industry. Its annual revenue growth has been around 50%.

Shopify’s growth comes from two main segments: Merchant Solutions and Subscription Solutions.

The Merchant Solutions business includes tools that enable sellers to serve their customers better and sell more products. And they are more correlated with clients’ Gross Merchandise Volumes (GMVs). Within Merchant Solutions, the group offers Shopify Payments, Shopify Shipping, Shopify Capital (working capital lending), and the Shopify POS (point of sale) system.

Subscription Solutions offer merchants of all sizes monthly recurring subscription plans that cost from under $10 to over $2,000 per month. In other words, there are different tiers for different-sized merchants. Many analysts highlight the importance of the monthly recurring revenue (MRR) for the future strength of the company.

Many on Wall Street credit the company’s success with a wide range of tools that enable store owners to easily manage their businesses.

Based on the growth story, there’s certainly a bull case to be made for SHOP stock extending far beyond 2019, but it is plagued by over-valuation concerns. Therefore, in the next earnings report, Wall Street would like to see the guidance for the rest of the year to increase.

What to Expect in SHOP’s Q3 Earnings

On Aug. 1, SHOP stock reported strong Q2 results that beat analysts’ average estimates, thanks to strong demand for its subscription solutions. On an adjusted basis, the group earned 14 cents per share.

Shopify stock’s revenue of $362 million surpassed the $350 million expected by analysts. It was a 48% increase from the comparable quarter in 2018. Merchant Solutions revenue grew 56%, to $208.9 million. Subscription Solutions revenue grew 38% to $153 million.

Shopify Plus, the premium version of Shopify, has over 5,300 customers, including names like Johnson & Johnson (NYSE:JNJ), Unilever (NYSE:UL), and the Obama Foundation. About a quarter of the company’s monthly recurring revenues comes from Shopify Plus merchants. Overall, Subscription Solutions is more profitable.

As of June 30, 2019, Shopify had an impressive $2.01 billion in cash, cash equivalents and marketable securities. A year ago, that number stood at $1.97 billion.

When Q3 results are released, investors may want to do due diligence to assess whether the number of stores and merchants will continue to grow, whether SHOP stock’s subscription revenue will continue to grow, and whether Shopify will continue to offer merchants a technological lead in the e-commerce platform.

However, Shopify has not yet reported any profits. And investors may have to wait several quarters before they see any meaningful profits.

Could SHOP Stock’s Margins Become a Worry?

CEO Tobi Lutke recently stressed that SHOP would continue to innovate and launch new products and services for both merchants and their customers. Wall Street also expects the company to continue to grow via acquisitions.

Over the summer, Shopify stock has announced that the group is entering physical fulfillment business. It will offer sellers access to a network of dedicated U.S. fulfillment centers to store and ship consumer goods for online orders. This move into logistics is likely to create new opportunities for the group. Management is hoping that Shopify merchants can now better compete with Amazon’s (NASDAQ:AMZN) expanding distribution capabilities.

SHOP bulls are happy to point out that the company’s increased logistics services are likely to add to revenue growth, which is showing no sign of slowing down. In Sept. 2019, management announced a $450-million deal last month to acquire 6 River Systems, maker of autonomous warehouse robots.

Yet some investors are now quite concerned that the logistics business will likely drive down the margins. SHOP stock’s success so far has been due to the core business of being a high-margin, high-growth software company. As of the end of June, SHOP stock’s gross margin stood at 56.57%.

However, Shopify has been exhibiting contracting gross margins especially in Merchant Solutions. Furthermore, in Q2 the company’s operating expenses increased by 49.9%.

If SHOP management cannot keep meeting the Street’s aggressive growth forecasts, then the owners of SHOP stock may become more concerned about its lack of profit, and Shopify stock could drop. Instead of focusing on profits, management wants to expand the company by launching new businesses. Therefore, those who plan to own SHOP stock over the long-term need to pay attention to the cash flows from its new ventures.

The Bottom Line on Shopify Stock

SHOP is a growth and speculative stock. Prior to the earnings report, I expect SHOP to be a battleground between investors and traders. While long-term investors would like to see Shopify stock go over the $350 level, traders are likely to keep it between $325 and $275.

In a few weeks, SHOP stock is likely to release another strong quarterly report. I’d like to analyze the statement before hitting the “buy” button.

Those who have benefited from SHOP’s 2019 gains may also consider taking some money of the table as we look ahead to the next earnings report. Alternatively, they may consider hedging their positions with covered call or put spreads.

If the earning report is another strong one, SHOP stock is likely to go and stay above $350. If SHOP stock’s quarterly report disappoints, then a move toward $250 or below could happen rather quickly.

From a fundamental valuation perspective, Shopify is still too expensive for me. However, there’s no doubt it’s an impressive growth company.

Many analysts indeed regard Shopify stock as one of the best e-commerce plays around. And it has been one of the top-performing stocks in 2019. Thus the strength of Shopify share price might be a good indication that within three or four years, investors who buy SHOP on weakness are likely to be rewarded handsomely.

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