Shopify: Get It Far Lower – Here’s Why

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Shopify: Get It Far Lower - Here's Why
Shopify: Get It Far Lower - Here's Why

We follow up on our post-FQ1 article on Shopify Inc. (NYSE:SHOP) with a detailed price action analysis. In our previous update, we posited that SHOP is likely at a near-term bottom. The price action has behaved according to our thesis, as it formed its near-term support close to the $305 level.

Notwithstanding, we have not observed any noteworthy bear trap (significant rejection of selling momentum); thus, SHOP remains well-entrenched in a bearish bias.

Our reverse cash flow valuation model indicates that the risk/reward profile of adding here is not attractive. We discuss why investors should wait for a deeper retracement toward its 2018 intermediate support before considering exposure. Notably, investors can consider adding exposure if it falls below $200 (pre-split). Investors should note that SHOP will trade on a split-adjusted basis from June 29.

Accordingly, based on June 24’s close, it implies a further downside of 48% before SHOP stock looks attractive again.

Due to its near-term consolidation, we reiterate our Hold rating on SHOP stock. However, we will reassess our rating if we observe a significant bull trap (significant rejection of buying momentum) below its intermediate resistance ($515) moving forward.

SHOP – Destruction After The Double Top Bull Trap

SHOP price chart

SHOP price chart (TradingView)

 

At its recent June lows, SHOP registered a decline of close to 82% from its double top bull trap, seen in November 2021. As a result, investors who bought into the expensive SHOP stock late last year have suffered tremendously.

Therefore, we think it’s critical for investors to pay close attention to price structures. Our experience with price structures has been beneficial when we heed its signals. In contrast, we were punished accordingly when we didn’t heed them.

JPMorgan (JPM) Asset Management CEO George Gatch noted recently that “he wouldn’t pay for his team’s parking ticket, but will gladly pay for their speeding ticket” if his team observed a “mountain face.”

Therefore, we believe it’s critical for investors to develop the “sensing skills” through price action analysis to assess such “mountains” like the case of SHOP. Moreover, it’s vital for high-growth stocks, given their premium valuation. In Shopify’s case, inconsistent free cash flow (FCF) profitability has not helped justify its aggressive revenue growth.

We noted that SHOP is likely at a near-term bottom, undergirded by its near-term support of $305. Notably, it has held its support since its May lows and absorbed the selling pressure in the June sell-off. Therefore, its price action is constructive for a near-term consolidation. However, we have not observed a bear trap, which is critical for SHOP to turn its bearish tide. Hence, we believe the market remains tentative over the direction of SHOP.

Moreover, investors must be extra cautious if another bull trap follows through at levels lower than its April bull trap ($710). Bull traps are often early warning signals of steep sell-offs to force rapid liquidation in investors’ positions.

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Hence, even if investors are considering adding at the current levels, we urge them to first wait for a re-test of its near-term resistance ($405). If a bull trap forms at that level, then be prepared for another steep selldown.

SHOP – Add Below $200 (Pre-Split), Not Now

Shopify revenue change % and FCF margins % consensus estimates

Shopify revenue change % and FCF margins % consensus estimates (S&P Cap IQ)

 

As a stock priced at a significant premium, the market will not be lenient if its FCF profitability is expected to be impacted significantly. It will markedly affect the FCF payback period, and the investors (including us) were given crucial lessons to model for consistency in FCF profitability during the growth stocks bear market.

Therefore, Shopify’s ongoing investments in fulfillment are estimated to affect its FCF margins markedly through FY24, as seen above. As such, investors need to adjust their expectations on SHOP stock and expect continued volatility as the market parses on how to value it accordingly. Moreover, given the Fed’s QT, we believe those revenue multiples-based valuations will no longer be so helpful. Therefore, investors are urged to refocus on FCF for at least the next few years.

Stock SHOP
Assumed entry price $200
Hurdle rate (CAGR) 25%
Projection through CQ4’26
Required FCF yield in CQ4’26 2%
Assumed TTM FCF margin in CQ4’26 9%
Implied TTM revenue by CQ4’26 $15.3B

SHOP reverse cash flow valuation model. Data source: S&P Cap IQ, author

SHOP is a high-growth stock, given its embedded growth premium (yes, it’s still traded at a premium). Therefore, we believe a hurdle rate of 25% that’s markedly above the market is appropriate. Notwithstanding, we applied a lower FCF yield of 2% to model for its focus on growth.

We used a TTM FCF margin of 9%, factoring in a discount based on the consensus estimates to account for a reasonable margin of safety.

As a result, we derived a TTM revenue target of $15.3B that Shopify needs to deliver in CQ4’26. Furthermore, it implies a revenue CAGR of 27.11% from FY21-26. Therefore, we believe it proffers Shopify more buffer to make mistakes/further investments by using an entry price of $200 and below.

Is SHOP A Buy, Sell, Or Hold?

We reiterate our Hold rating on SHOP stock. As it’s at a near-term bottom, selling now doesn’t make sense. If investors are considering layering out, they should cut exposure at its next bull trap.

Our valuation analysis suggests that SHOP could underperform the market even at the current levels. Therefore, investors should wait patiently for entry below $200 to help them obtain a less demanding valuation and markedly improve their chances of outperformance.