Why short sellers may regret their bets ahead of Shopify’s earnings

Open this photo in gallery:

Shopify Inc. SHOP-T will release its third-quarter financial results early on Nov. 12. Will the report provide further confirmation that its once robust financial flywheel – a self-reinforcing feedback loop in growth and financing that acquires momentum of its own – is again picking up speed and now on the verge of entering an unstoppable phase?

The flywheel first started up after Shopify’s IPO in 2015 and gained velocity as the company went on a streak of beating analyst expectations for 24 consecutive quarters. This stellar display of growth drove its stock to lofty heights, enabling Shopify to issue several new rounds of shares that brought in US$7-billion for financing further growth.

Alas, the flywheel faltered when Shopify’s valuation was inflated by the shift to online shopping during the height of COVID-19, only to be crushed when the pandemic waned and bricks-and-mortar stores reopened.

But signs of life now seem to be emerging. Over the past eight quarters, Shopify’s results have handily surpassed analysts’ forecasts, boosting its stock by 150 per cent.

This time around, consensus earnings for the third quarter of 2024 are currently projected to be US$0.27 per share, according to LSEG and Bloomberg data. The consensus estimate for revenues is projected to be US$2.115-billion.

Here is a tally of the earnings beats compiled by Zack’s Investment Research:

Half of the quarters drew frenzied endorsements from the market: share prices spiked upward by an average 21 per cent on the day the reports were released. Despite beating earnings, the other four quarters bombed with an average price collapse of 12 per cent, when weak guidance for the next quarter was provided.

Short sellers seem to think the coming quarterly financial report will be below projections and guidance for future quarters could be poor. Over the past 60 days, short sales increased by 30 per cent to US$2.7-billion (1.8 per cent of float).

According to seekingalpha.com, however, the dozens of sell-side analysts following Shopify have revised upward their earnings estimates 39 times and revenue estimates 42 times over the past 90 days. There were no downward revisions for earnings, and just one for revenues.

Such changes in analysts’ estimates are worth noting because academic research has found that upward revisions portend upward moves in stock prices (and vice versa). The revisions acquire greater significance as analysts obtain more up-to-date information closer to the release of quarterly reports.

Here are some of the highlights from analysts’ research notes in recent weeks:

• Spending trends from U.S Census Bureau data came in above consensus, implying better-than-expected sales for Shopify merchants.
• Conversations with agencies and merchants, as well as analyses of app usage, point to merchant sales and other metrics overtaking Street predictions.
• Channel checks gave grounds for optimism.
• Data from BuiltWith showed that the number of websites using Shopify in the third quarter increased by 40 per cent on a year-over-year basis, exceeding forecasts.
• Sensor Tower data indicated that monthly users of Shopify’s point-of-sale app climbed 58 per cent year over year.
• Reports of Salesforce losing clients to Shopify reinforce the view that Shopify’s initiatives in the enterprise, international and POS segments are achieving gains.
• Shopify continues to hold the line on headcount (job postings staying low), suggesting favourable news on operating leverage and margins.
• Shopify has a rich valuation relative to peers but several analysts believe that this is justifiable because its growth is outpacing rivals and increasing its market share.
• Shopify typically trades higher ahead of the Black Friday/Cyber Monday weekend.

Whatever the Nov. 12 report has in store, there should be more financial strength behind a flywheel if it got going this time around. During the 2015 to 2021 period, revenue growth carried the ball while operating income and free cash flow were negative most quarters, but now they are hugely positive.

Operating income for the past 12 months has averaged US$160-million per quarter; free cash flow for the past 18 months has averaged US$400-million per quarter. At these levels, Shopify is acquiring an ability to self finance, which could provide a degree of resiliency for the flywheel if some quarters underperform.

Larry MacDonald is a regular contributor to The Globe and Mail and author of a new book, The Shopify Story: How a Startup Rocketed to E-commerce Giant.