E-commerce specialist actions, Shopify (STORE 0.26%) soared on Thursday, October 27. Investors were reacting to a much better than expected third quarter earnings report. The next day, shares of Shopify’s main competitor, Amazon (AMZN -6.80%)fell about 10% in response to a lackluster third-quarter earnings report.
Can Shopify overcome competition from Amazon and still post results that drive its stock price higher? A strong performance in the third quarter suggests that the heavy investments the company is making in its distribution network are paying off as expected.
The Shopify distribution network
Despite climb recently, Shopify’s stock is still about 80% below the high threshold it set in 2021. The stock is crashing because instead of turning a profit in 2022, the company decided to invest heavily in its distribution network. To that end, the company acquired a logistics technology provider called Deliverr for $2.1 billion in May.
The Deliverr acquisition was Shopify’s largest to date, and signs so far suggest it was executed well. In September, SFN delivered more than two-thirds of national parcels within two working days. This represents an increase from less than 2% of parcels meeting a two-day deadline at the start of the year.
The company combines Deliverr with the Shopify Fulfillment Network (SFN) and the first SFN warehouse has already fully integrated the Deliverr technology stack. In just three months, the number of merchants holding inventory in this warehouse has increased tenfold.
Perhaps the biggest sign that investments in SFN are paying off is how quickly merchant solutions revenue is growing as a percentage of gross merchandise volume. In the third quarter, the attach rate to merchant solutions reached a record high of 2.14%, compared to 1.98% in the previous quarter.
Earning on Amazon?
In the third quarter, revenue for Amazon’s third-party seller services segment grew 18% year-over-year. Over the same period, Shopify saw total revenue increase by 22%. This isn’t an apples-to-apples comparison, but it does suggest that Shopify’s market share for third-party seller services is growing.
Amazon proved years ago that fast, reliable fulfillment can increase cart sizes and conversion rates for third-party sellers. The benefits are so powerful that third-party merchants willingly give up control of their customer relationships in exchange for access to Amazon’s distribution network.
SFN’s new ability to reliably handle super-fast shipping means merchants no longer need to trade control of customer relationships for the fast fulfillment services consumers have come to expect. As more SFN warehouses integrate with Deliverr, Shopify’s market share gains could accelerate.
Shopify shares are trading at an all-time low of 8.5x trailing sales. From this low starting point, further success for SFN could lead to huge gains in the quarters to come. Before investing heaps of hard-earned cash in this growth stock, it’s important to understand that the company has recently suffered heavy losses.
After losing $633 million in the first nine months of 2022, Shopify ended September with $4.9 billion in cash and securities. If the losses do not subside over the next few quarters, the market will punish the stock severely.
Soaring interest rates intended to fight inflation could tip the global economy into a deep recession and make it even harder for Shopify to avoid reporting more losses in 2023. I think heavy investments in SFN will eventually pay off, and I’m willing to watch my Shopify stocks languish until they do. It’s an easy position for me to take because my Shopify position is a relatively small part of a well-diversified portfolio. If you’re going to bet on continued gains for this security, it’s probably best to take a similar approach.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Cory Renauer has posts in Shopify. The Motley Fool holds positions 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.