Shopify's Q1 Preview: Margin Expansion is Facing Challenges

Shopify, Inc. ($SHOP) is set to report corporate first-quarter earnings results on Thursday, May 04. After an early-year recovery in January following heavy losses in 2022, investors have been hesitant to bid the price higher, although a modest rally has taken shape recently. The US-listed stock price has been capped below $50 per share since earlier this year.The likelihood of a recession in the United States and Canada has cooled investor sentiment, especially for consumer brands.

The consensus EPS Estimate is -$0.04 (vs. $0.20 last year) and the consensus Revenue Estimate is $1.44B (+20.0% Y/Y).SHOP is expected to report a loss for Q1 amid margin compression and a challenging macroeconomic environment.

Last quarter, GMV rose 13% year-over-year to $61 billion, beating estimates of $5.91 billion and outpacing overall U.S. retail growth of 6%, thanks to strong spending during the holiday season.

The possibility of GMV meeting expectations in the first quarter is still relatively high. Judging from the financial report of competitor Amazon, the revenue performance of the e-commerce retail business in the first quarter, both in North America and in international regions, exceeded market expectations. In the first quarter, Amazon’s retail business in North America increased by 11% year-on-year, exceeding market expectations of 9.1%; the revenue of the international retail segment also stopped the decline in the past five quarters, with a year-on-year increase of 1%, exceeding market expectations of -3.9% %. To a certain extent, the reason may be that in the context of weak consumer spending, the e-commerce business is relatively more resilient due to its more cost-effective.

But the outlook for the second quarter may be less optimistic, looking at Bank of America's credit card and debit card spending data for US households, since the end of 2022, the monthly growth rate of credit card and debit card spending has declined rapidly month-on-month, which indicates consumer sentiment worsening sharply, the current uncertain macro environment keeps U.S. consumers from buying optional goods.

In the last quarter, the growth rate of shopify's operating costs was much higher than that of revenue growth, mainly due to the impact of the acquisition of logistics companies and continuous investment in new companies. Since Apple launched its new privacy policy in April 2021, the advertising environment has changed, and internet companies that use advertising to drive consumers have suffered a huge blow. In this case, it is difficult for the advertisements placed on social media by Shopify’s independent stations to accurately reach consumers and affect the conversion rate of products. In order to get rid of the negative pressure brought by Apple's new privacy policy, Shopify chose to invest in companies with innovative marketing methods.

In a fiercely competitive environment, it is difficult for Shopify to effectively control costs. While Shopify complements the logistics sector through acquisitions, it also leads to an increase in operating costs. At the same time, research and development costs are high.

In January 2023, Shopify announced that it would increase the prices of Basic, Shopify, and Advanced by more than 30%. Raising plan prices could lead to churn, but given the lack of options for e-commerce companies offering comparable products and services, there is little risk of merchants actually leaving the Shopify platform when the subscription price hike goes into effect in April

In order to capture more opportunities, the company is now focusing more on larger brands and I believe this will be a major growth catalyst moving forward.

The company has been targeting larger brands through Shopify Plus and it recently launched Commerce Components, its enterprise retail solution. Commerce Components is a compostable stack that allows enterprises to integrate Shopify's components with their own systems through APIs. The infrastructure enables next-level customizations and vastly increases flexibility for customers with specific needs. The new solution has already onboarded notable customers such as Mattel (MAT) which owns about 400 toy brands in its portfolio.

As the company continues to shift to a transaction-based revenue model, the importance of larger clients magnifies further. SMBs tend to offer little value under a transaction-based model as their GMV (gross merchandising volume) is usually pretty low and volatile due to unestablished fundamentals. On the other hand, enterprise customers generally generate a lot more value over time as they have high and steady-growing GMV.

In 2018, revenue from subscription solutions accounted for roughly 50% of total revenue. The figure has been declining and now only accounts for just 23% of total revenue, as shown in the chart below. The figure should continue to decline as the penetration of Shopify Payments increases over time.

The higher the transaction volume on the Shopify platform, the higher the variable share of merchant solutions. However, the rising penetration of transaction-based revenue is a double-edged sword. As the economy continues to weaken with a potential recession looming, this may become a notable concern as spending will likely drop substantially.