Shopify Inc (SHOP) NPV

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Shopify reported a 26% rise in third-quarter revenue to $2.2bn. Growth was broad, driven by a 24% increase in orders processed through the platform by value.

Operating profit rose from $122mn to $283mn (30% better than expected) as margins saw a significant improvement driven by the combination of top line growth and cost control.

Free cash flow rose from $276mn to $421mn. Net cash, including leases, was $3.8bn at quarter-end, in line with the start of the year.

Fourth-quarter guidance includes revenue growth in the “mid-to-high-twenties percentage rate” and operating costs at 32-33% of revenue.

The shares rose 13.8% in pre-market trading.

Our view

Shopify is a commerce powerhouse. But rather than selling products itself, it provides the internet infrastructure for businesses to operate online. Its platform simplifies the complex world of online retail, offering a range of tools for businesses of all sizes to create and manage their online shops. This covers website templates to payment processes, and everything in between.

After a disappointing start to the year, the past couple of quarters have seen things get right back on track. Although not pulled out specifically, fourth-quarter guidance suggests a mammoth 40% upgrade to where operating profit estimates were before results. That’s a large reason for the very positive market reaction.

Perhaps unsurprisingly, the shift towards digital shopping has been a major growth driver for Shopify. The group’s valuation has come down some way since the immediate aftermath of the pandemic, when we were all living exclusively through digital means, but remains relatively elevated. That reflects excitement from the market, while also increasing the risks of ups and downs.

We share some of this enthusiasm, particularly for the group’s subscription-based revenue, which it collects from sellers to use its platform. While these make up a smaller portion of overall revenue, it’s still a more resilient and profitable source of income than the slice it collects on each sale.

Investments are being made to expand the range of solutions clients can subscribe to. But for now, the merchant solutions segment, including transaction fees, still contributes around two-thirds of group revenue, tying Shopify’s success closely to that of its customers.

While Shopify boasts large clients like Pepsi and Netflix, its typical customers are small and medium-sized businesses that tend to be more susceptible to the health of the broader economy. While there’s been an underlying fear that conditions could weaken, Shopify hasn’t seen any real impact from its customers yet.

The group’s been keeping a tight grip on costs and making sure the headcount remains stable is a real focus. Coupled with shedding the financial burden of its unsuccessful logistics company last year, this should help support margin growth and cash generation.

Overall, we’re impressed by Shopify’s leading proposition and ability to integrate itself into merchant’s operations. There are several potential growth levers; from the value of orders through the platform, which has continued to grow, to the adoption of its services from larger players. But the valuation, given the recent strong performance, already has a lot of those strengths built in and so could be sensitive to missteps.

Environment, social and governance risk

The technology sector is generally medium/low risk in terms of ESG, though some segments are more exposed, like Electronic Components (environmental risks) and data monetisers (social risks). Business ethics tend to be a material risk within the tech sector, ranging from anti-competitive practices to intellectual property rights. Other key risks include labour relations, data privacy, product governance and resource use.

According to Sustainalytics, Shopify’s management of material ESG issues is average.

ESG reporting is in place and the board is responsible for overseeing ESG issues, but reporting does not align with leading best practices. Data privacy is an important risk, and it’s being managed well but with room for improvement. There haven’t been any major controversies from a data or cybersecurity standpoint, but it could do with improving regular risk assessments.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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