Shares of e-commerce specialist, Shopify (SHOP -1.62%) shot up on Thursday, Oct. 27. Investors were responding to a third-quarter earnings report that was far better than expected. The following day, shares of Shopify's largest competitor, Amazon (AMZN -1.45%), fell about 10% in response to a less-than-encouraging third-quarter earnings report.
Can Shopify overcome competition from Amazon and continue reporting results that push its stock price higher? A strong performance in the third quarter suggests the heavy investments the company is making in its fulfillment network are paying off as intended.
The Shopify Fulfillment Network
Despite climbing recently, shares of Shopify are still around 80% below the high watermark they set in 2021. The stock is tanking because instead of generating a profit in 2022, the company decided to invest heavily in its fulfillment network. To this 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's been well executed. In September, SFN delivered more than two-thirds of domestic packages within two business days. That's up from less than 2% of packages meeting a two-day deadline at the beginning of the year.
The company is combining Deliverr with the Shopify Fulfillment Network (SFN) and the first SFN warehouse has already fully integrated Deliverr's technology stack. In three short months, the number of merchants holding inventory in that warehouse grew tenfold.
Perhaps the greatest signal that investments in SFN are paying off is how quickly merchant solutions revenue is growing as a percent of gross merchandise volume. In the third quarter, the merchant solutions attach rate soared to an all-time high of 2.14% from 1.98% in the previous quarter.
Gaining on Amazon?
In the third quarter, revenue from Amazon's third-party seller services segment rose 18% year over year. Over the same time frame, Shopify reported total revenue that rose 22%. This isn't an apples-to-apples comparison, but it does suggest that Shopify's share of the market for third-party seller services is increasing.
Amazon proved years ago that fast and reliable fulfillment can boost cart sizes and conversion rates for third-party sellers. The benefits are so powerful that third-party merchants gladly give up control of their customer relationships in return for access to Amazon's fulfillment network.
The newfound ability of SFN to reliably handle ultra-fast shipping means merchants no longer need to trade control of customer relationships for the speedy fulfillment services consumers have come to expect. As more SFN warehouses integrate with Deliverr, Shopify's market-share gains could accelerate.
Still risky
Shares of Shopify are trading at a historically low price of 8.5 times trailing sales. From this low starting point, further success for SFN could lead to enormous gains in the quarters to come. Before you plow heaps of hard-earned money into this growth stock, though, it's important to understand the company has been reporting some heavy losses lately.
After losing $633 million in the first nine months of 2022, Shopify finished September with $4.9 billion in cash and securities. If the losses don't subside over the next several quarters, the market will punish the stock severely.
Soaring interest rates meant to fight inflation could tip the global economy into a deep recession and make it extra difficult for Shopify to avoid reporting more losses in 2023. I believe that heavy investment in SFN will eventually pay off and I'm prepared to watch my Shopify shares languish until it does. It's an easy stance 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 stock, it's probably best to take a similar approach.
