AAfter a few years in test mode, Shopify (NYSE: SHOP) said it is increasing investment in its distribution network through 2024. This increase in spending will affect in the short term but will ultimately expand Shopify’s booming and highly profitable e-commerce platform. What does this mean for investors?
Well, that could mean a turnaround for a stock that has suffered a steep price drop of 62.3% from all-time highs recorded in mid-November. After the price correction, the stock is currently trading at a much more reasonable price of 27x trailing 12-month earnings at the time of writing. That’s not to say the stock is cheap, though. On the contrary, with a large increase in distribution network spending ahead, it is still a “growth first, profit second” stock, and this P/E ratio will increase again (more because of the side benefits of the equation).
Still, given Shopify’s track record of hitting lofty goals, this planned jump in investment could be great news for long-term shareholders looking for a turnaround.
Image source: Getty Images.
Power to the small merchant
What is Shopify Fulfillment Network (SFN)? It might sound like a fancy way of saying “order delivery,” but it goes way beyond shipping boxes to a customer. Shopify’s goal with this service is to help small merchants provide some of the same great services that Amazon (NASDAQ: AMZN) buyers grew to wait. Shopify President Harley Finkelstein explained during the fourth quarter 2021 earnings call that upcoming changes to the Fulfillment Network could help “deliver packages in two days or less to more than 90% of the U.S. population. while minimizing inventory investment for DFS merchants.”
SFN is a game-changing feature for small merchants. E-commerce has the potential to empower small entrepreneurs and business owners, but the logistics are difficult without the massive scale enjoyed by Amazon, big-box retailers and others. Shopify wants to change that.
It’s simple, at least in principle. A merchant ships inventory in bulk to Shopify warehouses nationwide. The merchant then sells through different Shopify channels (a website, social media, etc.). Shopify automatically picks inventory from the nearest warehouse and fulfills the order. The merchant performs continuous inventory management through a dashboard, which recommends which products to restock and where.
Of course, the actual technology that works behind the scenes to power the SFN is no simple task (more on that in a minute). But if you’re a small business owner and dream of selling nationally and beyond, the relative simplicity of SFN offerings might be a dream come true, especially since Shopify itself doesn’t. is not a retailer and does not compete with merchants using its services (as Amazon does).
About the SFN Award…
Like any good capital investment in new technology, SFN will need cash to get started. After all, those warehouses full of robotics and AI-based software don’t come cheap. Since announcing the warehousing and fulfillment project a few years ago, the company has so far made only modest investments there. According to Shopify CFO Amy Shapero:
When we launched Shopify Fulfillment Network in mid-2019, we announced that we planned to spend $1 billion over five years. Through 2021, roughly halfway through the original asset light plan, we have spent $117 million, which includes operating loss funding in cash and a small amount of capex.
What does it mean? Shapero added that DFS spending will increase in 2022 and there will be $1 billion in capital expenditures (property and equipment) in 2023 and 2024. In other words, DFS is moving from prototype to full service. Capital expenditures were only $50.8 million in 2021, so this figure will increase over the next three years. So much for this “asset light” software business model.
But here’s the good news: Shopify is currently generating free cash flow (FCF) and has plenty of cash. FCF was $454 million in 2021 alone, and cash and short-term investments net of debt were nearly $6.9 billion at year-end. Shopify can afford to extend SFN and more.
Takeaway for investors
The expected increase in capital spending over the next few years is why I’m hesitant to say that Shopify is “cheap” right now based on its price-earnings ratio of 27. Current earnings will be reduced spending on SFN in the years to come.
But again, this company should not be underestimated. Although revenue growth is moderating from the 57% increase in 2021, double-digit growth from a company that just achieved $4.6 billion in sales is no joke. Shopify Fulfillment Network will be an exciting development to follow as Shopify continues to support entrepreneurship in a new era of e-commerce.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Nicholas Rossolillo and his customers own Shopify. The Motley Fool owns and recommends Amazon and Shopify. The Motley Fool recommends the following options: $1140 January 2023 Long Calls on Shopify and $1160 January 2023 Short Calls on Shopify. The Motley Fool has a disclosure policy.
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