Shopify’s valuation is just too scary, this investor says

The pandemic may be a ripe time to make hay for e-commerce companies like Shopify (Shopify Stock Quote, Chart, News TSX:SHOP) but it’s been too much, too fast, according to Stan Wong of Scotia Wealth, who advises investors to take a breather on the stock.

“Certainly, this pandemic has helped e-commerce companies like Shopify, but one of the things that worries me about Shopify is when you look at valuation is trading at 500x forward earnings,” says Wong, director of wealth management at Scotia Wealth, who spoke on BNN Bloomberg on Wednesday.

Shopify’s share price has ballooned by 155 per cent so far in 2020 amid a surge in online shopping as a result of COVID-19 lockdowns and store closures. When the year is all over in a couple of months, bricks and mortar business could be down by as much as 60 per cent while online commerce is expected to grow by 20 per cent.

And while much of that in-store business should return once the pandemic is behind us, there are strong demographics in e-commerce’s favour. A recent PwC survey found that where 58 per cent of respondents are already more comfortable returning to shopping at a grocery store and 44 per cent comfortable with retail stores, the overall gap between Baby Boomer online activity and that of Gen Z is significant, with 37 per cent of Gen Z’s buying clothing and footwear online versus 16 per cent for Boomers and 35 per cent of
Gen Z’s buying groceries online versus ten per cent for Boomers.

“The shift to working from home has been accelerated by COVID-19. As more organizations settle into new ways of working, there will be significant implications for retail strategies given the link between work-from-home arrangements and other demographic and consumer trends,” the PwC report said.

It’s that bullish sentiment which is helping to boost Shopify’s valuation, which is a reasonable connection, says Wong, but not enough to make him turn a blind eye to SHOP’s share price.

“Certainly, this pandemic has helped e-commerce companies like Shopify, but one of the things that worries me about Shopify is when you look at valuation is trading at 500x forward earnings…”

“Yes, we have very, very strong growth prospects for Shopify at about 50 per cent long-term earnings growth, so it certainly makes sense from that perspective. And sales growth obviously is is going to look very strong with a probably around 30 to 40 per cent sales growth over the next few years,” Wong said.

“But I think that we’re paying a bit of a premium for this particular name. The pandemic has helped them from the perspective of an acceleration in e-commerce sales and so forth but valuation keeps me at bay for the time being,” he said.

The market will be paying extra attention to Shopify’s third quarter earnings due next Thursday, looking for a repeat of the Q2 where SHOP almost doubled revenue from a year earlier and saw the number of new stores joining its platform increase by 73 per cent over the previous quarter. Earnings for the quarter were $1.05 per share which was way ahead of the Street’s consensus at $0.02 per share. (All figures in US dollars.)

How much of that growth baked into Shopify’s current share price will actually become reality is unclear, but there are many who like the company’s chances of hitting Amazon-like dominance in the e-commerce space.

Wedbush analyst Ygal Arounian likes Shopify’s moves to build out its fulfillment network , saying in an update to clients last month, “We continue to like the short-term trends and Shopify’s position to capture them. SFN (Shopify Fulfillment Network) and POS (Shopify Point of Sale) are key initiatives that get Shopify towards its vision of a retail OS, rather than an e-commerce platform.” Arounian moved his rating from “Neutral” to “Outperform.”

Earlier this month, KeyBanc Capital analyst Josh Beck maintained his “Buy” rating and raised his one-year target from $1,150 to $1,250 , saying the company’s development into an Amazon competitor has promise. Beck said SHOP’s fulfillment network buildout has resulted in “a full-fledged, tightly integrated fulfillment solution for Shopify merchants and includes order/inventory management solutions, branding and data controls, and access to scalable, flexible warehousing space to sell across multiple channels.”

For the opposing perspective, Morgan Stanley analyst Keith Weiss said Shopify’s share price already has its future success priced in . Weiss said the COVID-19 pandemic “has accelerated adoption across the e-commerce landscape, though for Shopify the path to durable, sustained growth comes from more than just exposure to temporal impacts.”

Weiss estimates SHOP to be trading at 23x his ten-year free cash flow forecast, whereas Amazon is trading at the same multiple for just three years from now. “We would look for a more attractive entry point, either on a pullback or early indications that estimates have to move meaningfully higher,” Weiss said.

The analyst has a one-year target for SHOP of $970 per share and gives the stock an “Equal Weight” rating.