Shopify stock (NYSE:SHOP) plunged by over 20% after its Q1 results despite an outstanding quarter marked by accelerating revenue growth, robust margin improvements, and a surge in free cash flow. The share price decline was likely due to Wall Street finding the company’s guidance rather underwhelming, particularly against the backdrop of Shopify’s lofty valuation. Given that shares could still be overvalued even after the recent dip, I am neutral on SHOP stock.
Exceptional Growth Across Every Metric
Despite what Shopify’s post-earnings market reaction might imply, its Q1 report displayed exceptional growth across every single metric that matters. Starting with its top-line growth, Shopify shows no signs of slowing down, as revenues grew by 23% to $1.9 billion. Adjusted for the sale of the company’s logistics businesses, revenues actually grew by 29%, which even implies an acceleration compared to last year’s revenue growth of 25%.
Growth was once again driven by impressive gross merchandise volume (GMV), continued subscription growth, and the rising penetration of Shopify Payments. Regarding GMV, it came in at $60.9 billion in Q1, an increase of 23% year-over-year. This also suggests an acceleration compared to last year’s first-quarter GMV growth of 15%.
This year, the surge in GMV growth was propelled by robust same-store sales growth among Shopify’s established merchants, alongside an influx of new merchants embracing the Shopify platform. It’s worth noting that management said existing merchants played a slightly larger role in driving this expansion. This clearly underscores the remarkable resilience of consumers, who maintain purchasing momentum at their favorite stores despite lasting worries about inflation and consumer credit conditions.
The influx of new merchants to Shopify’s platform and the rise of subscription prices recently led to Subscription Solutions revenues growing by 34% year-over-year to $511 million. Lastly, regarding the increased penetration of Shopify payments, Shopify reported that 60% of the GMV processed in Q1 was via Shopify payments, up from 56% last year. With Shopify generally charging 2.9% + 30¢ for each such transaction, higher penetration fueled Merchant Solutions revenues to $1.4 billion, up 20% from last year.
Great Margin Improvements, Strong Free Cash Flow Growth
Shopify’s ongoing expansion has gradually led to a margin expansion, resulting in strong free cash flow growth. Take the recent price increases in Shopify’s standard plans recently, for instance. That’s an instant revenue driver for the company without having to incur additional costs. The same is true when it comes to increased Shopify Payments penetration. As it expands, Shopify essentially collects extra revenues from processing with virtually no incremental expenses.
Thus, Shopify’s gross margin expanded to 51.4% in Q1 from 47.5% last year (see below). Consequently, free cash flow came in at $232 million or 12% of revenue, doubling as a percentage of revenue compared to last year’s first-quarter free cash flow margin of 6%. In fact, this was the third consecutive quarter of a double-digit free cash flow margin, and management commented that they don’t expect this trend to change anytime soon. This signals continued free cash flow growth and strong revenue growth momentum.
Q2 Outlook Suggests Shares Could Still be Overvalued
Speaking about momentum, Shopify appears poised to sustain strong growth. However, this doesn’t mean that shares are still not overvalued at their current levels. This is most likely why Wall Street sold off the stock post-earnings.
Management’s Q2 outlook anticipates robust revenue growth, which is expected to grow by a high-teens percentage rate year-over-year. When considering the impact of the divestiture of the logistics arm, this forecast translates to a year-over-year growth rate in the low-to-mid 20s. While undeniably a strong performance, it does signal a deceleration compared to Shopify’s Q1 results.
Now combine Wall Street’s fear of a slowdown with the fact that shares trade at a rich valuation, and it’s pretty easy to see why shares sold off-post earnings. The striking part is that SHOP stock could still be expensive even after its dramatic drop. At nearly 61 times this year’s expected earnings, the stock is by no means cheap. While the company could sustain growth of 20%+, partially justifying this valuation, there is little to no margin of safety for current investors if there is a notable slowdown in growth, moving forward.
Is SHOP Stock a Buy, According to Analysts?
Following Shopify’s significant share price plunge, Wall Street seems somewhat bullish on the stock. The stock features a Moderate Buy consensus rating based on 15 Buys, 14 Holds, and one Sell assigned in the past three months. At $77.04, the average Shopify stock forecast implies 32.8% upside potential.
The Takeaway
Reflecting on Shopify’s Q1 report, the post-earnings plunge seems justified. While Q1 showcased impressive growth across all key metrics, the market’s reaction reflected concerns over the company’s guidance and lofty valuation. In fact, even though Shopify’s Q2 outlook suggests lasting growth, caution is warranted, as shares could potentially still be overvalued at their current levels, especially if a slowdown were to take place.
