Motley Fool Hidden Gems Investing - Shopify Retreats, Amazon Attacks

Starting point is 00:00:00 Amazon's next target is shipping on Motley Fool Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. As we've said before, new name, same great podcast. I'm Tyler Crowe. I'm your host today. I'm joined by longtime Fool contributors, Lou Whiteman and Matt Frankel. As I mentioned in the headline, we're going to talk about this new move that Amazon is doing by going into the shipping and logistics business in ways that they've never done before. Also, we're going to answer some listener mailbag questions. But first, we want to start with the topic that we started to the day. It is earnings season, so we want to get into earnings at Shopify. Shares of Shopify are down about 9% as we are

Starting point is 00:00:42 taping this podcast today. And it was down as much as 10% both in pre-market and early market trading this morning after the company released first quarter earnings. Of all the three of us here, I am kind of the non-Shopify follower here, so I'm going to lean on you guys. But when I first looked at the press release, I would say in a vacuum, the numbers looked fine. Revenue was up 34% year over year. Gross merchandise volume, which the amount of stuff that was bought on its platform, would pass $100 billion for the first time. Net income, taking out some investment gains and losses that aren't really related to the actual operating business, was $360 million. Though, here's the knock. It did miss expectations for the quarter. And this is the second quarter

Starting point is 00:01:24 in a row that it actually missed Wall Street expectations for operating earnings. So guys, I want to get your thoughts on this. And was this missing Wall Street earnings for the second time kind of adding to AI jitters? Was it maybe just Wall Street's expectations being a little too high? When you saw these results, how did you see them? Matt, let's start with you. Well, like pretty much any other stock in earnings season, it's all about expectations. Shopify grew revenue by 34% in the first quarter, but they're guiding for full-year revenue growth in the high-20s range. If you have 34% in the first quarter, high-20s the rest of the year, the law of averages tells you you're going to have a slowdown as you head into the rest of the year.

Starting point is 00:02:06 I'm not as worried about the net income number and the net income miss. I don't think that's what's driving the stock here. If a company's growing sales at 34% year-over-year and is profitable, then that's great in and of itself. Shopify is in a very investment-heavy phase right now. As you mentioned, it's trying to keep up with AI headwinds and things like that. That can make bottom-line income kind of lumpy, but we really need to show the revenue growth to justify the spending. It needs to keep revenue growth at an elevated enough level, and it doesn't sound like they gave an optimistic enough outlook to satisfy investors with the stock trading at 65 times forward earnings, more than 12 times sales, whatever metric you want to use,

Starting point is 00:02:48 it's an expensive stock. Yeah. And that's the thing. It's funny because we're all guilty of it. We all like scoreboards, right? So we look at what the stock is doing and say, bad quarter, bad company, good quarter, good company. And sometimes, usually, it's not that simple. Tyler, yeah, it looked good in a vacuum. It looked good in a dustbin. It looked good in a Swiffer. It looked good. This was a good quarter, but everything is relative. Valuation is returning to earth, but arguably not yet on earth. And when you traded a premium, you are expected to deliver a premium return. Shopify's guidance doesn't clear the bar for me. And apparently it doesn't clear the bar for the market either. And I think that's basically, you know, not company bad, company

Starting point is 00:03:31 good. I think that's the conclusion. I'd note here, too, is like, oh, if you look at five years, Shopify is basically flat. They're like up, I think, 1%. Now, they've been up 80% and cut in half during that period. So this is a company that tends to swing violently around different moods. I own the stock. To me, it's a definition of a hold. If it comes down, it may begin to look interesting to add to it. But we also have the weaker consumer still looming as a question mark. I think this is just focus on the long term and not get too caught up on 20% versus 30% in any one quarter. Matt, I want to dig a little bit more into what you were mentioning about this being an investment heavy phase for the company, because this is something that I found a little

Starting point is 00:04:16 peculiar as I was looking through the press release. I was looking at the financial statements and this is where it gets, something feels different to me and I'm trying to figure it out. it has lots of cash and it also holds a lot of equity in long-term investments in other companies relative to like the total balance sheet of its size you know i would expect high amount of investments in other companies if you know it was like an insurance company or something like that going out and making investments you know investing in the float but this is an e-commerce software and platform company that's looking to invest in its platform looking to you know build out better multi-channel solutions for its clients, as well as fending off this world of

Starting point is 00:04:59 AI, like how does Shopify fit in this world of AI? Yes, the company throws off a lot of free cash flow, and it has more than its needs. Holding onto equity is not a big deal, but three-quarters of its balance sheet is either cash, equivalents like treasuries, or investments in other companies. Now, considering the quarter, missing earnings expectations, being in this investment-heavy phase, as you mentioned, it seems like something's not squaring here. Either management's, I would say, distracted by side quests of owning other companies rather than dedicating and allocating that cash back into the business to build out what it wants to do. Now, Lou, I want to start with you and then we'll get to Matt. So look, they haven't done a secondary offering since 2021.

Starting point is 00:05:43 They have almost no debt. They are investing with free cash flow. I wouldn't sell these investments just because, unless you need to. And it doesn't look like they need to. Matt can get into it. I don't think that this is really a distraction on management's time. I don't think they're out doing the Warren Buffett thing, reading through 10-Ks, trying to find companies to invest in, things like this. This is trying to capture upside of partnerships, I think, Matt. I mean, you can get into that. But this, to me, I don't have a problem with. You correctly pointed out that three-fourths of the balance sheet is investments and cash and equivalents, which-

Starting point is 00:06:20 I'm a big fan of having a lot of cash and equivalents on the balance sheet, first of all. So that's a big positive for Shopify. But for the most part, and Lou kind of mentioned this, the outside investments were the results of partnerships. So for example, the largest investment Shopify has in a publicly traded company that's not Shopify is Affirm. They own a roughly $1.5 billion stake. And it started when Affirm became the exclusive provider of ShopPay installments, even before they went public. They granted Shopify warrants as part of the deal at a one cent exercise price. So it was really a deal sweetener to be, you know, we want exclusivity on your new product and we'll give you some equity in our company.

Starting point is 00:06:58 A similar situation occurred when Global Eve formed a cross-border logistics partnership with Shopify in 2021. They got equity as part of the deal. And Shopify's management has specifically said several times that these investments aren't relative to the fundamentals of its business. they're not what management's focused on. They're smartly negotiated perks in exchange for partnerships, not a core part of their strategy. After all, like I said, a firm literally costs next to nothing. I don't dislike this part of the strategy. I don't think it's a distraction for management. Okay, that's fair. I mean, I guess looking at, again, in the vacuum, less familiar, you see all these equity investments. You're like, that doesn't make a lot

Starting point is 00:07:34 of sense. The one thing I would point out, though, is that this is a company that does use a lot of stock-based compensation, and throwing off a lot of cash while throwing off a lot of stock-based comp, you know, maybe start using some of that cash to pay some investors or pay your employees and, you know, let the investors not get diluted as much. I wouldn't argue against that at all, Tyler. Coming up after the break, Amazon's daring move into supply and logistics. The transportation and logistics industry kind of got rocked yesterday after Amazon announced it was launching Amazon supply chain services that would allow third party businesses to use Amazon's existing supply chain network that it uses for its internal shipping and transportation and all

Starting point is 00:08:12 that stuff, and allow those third-party businesses to basically latch on and use these services just like it was cloud services or any other pay-for type of service that Amazon provides. Now, there were dozens of companies in trucking, shipping, logisting stocks that dropped sharply in the news. And I think the biggest examples of it, and probably the most well-known names that this happened to is companies like UPS and FedEx, both declining nearly 10% on the move. So I want to get into this question here is, will this really upend UPS and FedEx? I mean, we can go in a lot of different ways, but the supply chain offering is much more than just shipping for what Amazon's

Starting point is 00:08:52 doing. It's doing fulfillment, storage and warehousing, air and ground freight, its ability to do store fulfillment, letting customers use its in-house multi-channel fulfillment software and integrations this is not just like you know give us your stuff and we'll ship it for you so my question is is this the type of solution that would allow someone to spy logistics of box solution and kind of bypass a lot of this other stuff I would say kind of rendering UPS FedEx I wouldn't say obsolete but definitely less relevant I think it's a lot more that on offer here than what a basic shipper can really can yeah it's interesting because for one thing we don't know exactly what Amazon is going to offer here they didn't really get into details

Starting point is 00:09:33 Reading between the lines, I don't think they're targeting logistics in a box, like do the whole thing. I don't think they really necessarily want to get something to the house. They are doing B2B. So if you think about it, if you're say Honda and you are shipping parts to dealerships all over the country, to get those parts from the port of Los Angeles to all your dealers, store them until the dealers need them, that's the part they're going after. It's more predictable. It's more lucrative. And I think the concern for a UPS or a FedEx is that if their margins disappear there, it puts pressure on the entire system. It makes some of the less profitable parts of the business that are maybe kind of subsidized by the B2B, by this back office, it puts them at risk.

Starting point is 00:10:16 All in all, I'm kind of curious, there's a weird kind of tension here between did Amazon really substantially overbuild to the point where they could actually take on even just a fraction of what UPS and Amazon has? Or are they going to commit billions in CapEx here to build this out at the same time they're building data centers? It has to be one or the other. And I doubt it's A, and I don't think they're going to be B. So I think they're a player here, but I don't think they're just going to annihilate everyone or take everyone's business. Yeah. Lou kind of alluded to this, but commercial freight, which is what he's talking about there with the Honda parts and things like that, that's the highest margin part of FedEx and UPS's business, period. Amazon,

Starting point is 00:11:02 it specifically names some lucrative customers. Honda wasn't one of them, but Procter & Gamble and 3M were, and those are major, major shippers. Even if Amazon doesn't completely disrupt the businesses of FedEx and UPS, the emergence of a major player like Amazon, it does create pricing pressure, especially because Amazon, with excess capacity, like Lou mentioned, has at least at the start a favorable pricing structure. There's a solid argument to be made that if there was a real threat of disruption, we would have seen these stocks down more than 10%. If Amazon took a 10% share of the market, the hit to FedEx and UPS on the bottom line would probably be significantly more than 10%, especially when you think long-term. I'm not that worried. I think it's really just

Starting point is 00:11:43 a knee-jerk reaction. Yeah. Here's the other part I'm trying to figure out, too. From the Amazon side is the why now. Obviously, UPS has been struggling a little bit lately with its decision to shrink, to focus on B2B, to focus on healthcare shipping, less volume, more margin kind of business, kind of what Amazon seems to be attacking here. And maybe it's a strike while the competitors are down or something like that. But what is most curious to me about Amazon's decision now, this is in the midst of a massive AI infrastructure build-out that it's taking on. It's hundreds of billions of dollars in capital to make it happen, not just this year, but for the next several years. Amazon's capital expenditures are in the $175 to $200 billion

Starting point is 00:12:27 range already. So now we're going to layer on spending to meet growing supply chain and logistics businesses. I mean, yes, it has an existing system already, but if you were going to start taking on volume for the third parties, it's obviously going to require more capacity. And so I'm curious as to why go into this when you have this lucrative AI infrastructure section that you're going into it. It makes me wonder, like, how much money do you want to spend? Because this is already telling up to be a very large bill. The why now is a great question.

Starting point is 00:12:58 And to some extent, the answer is this was always the plan. So it might just be they've built out the critical mass to make it possible. That took time. And so they're just doing it now because they can. Tyler, I do think that this could be a sign of a capital constrained company because the weird thing about this is they have to build all of this for their own business. So instead of adding CapEx in a way, this offsets CapEx. If you can monetize some of it, turn it into revenue. So in a world where Amazon does have to continue to scale logistics and they are trying to spend

Starting point is 00:13:34 billions in a data center, maybe trying to get some of that logistics spending covered by third parties. If you think of it that way, instead of just kind of investing in the business kind of just for the revenue, I think it might make more sense. But again, I do think it speaks to what Matt was saying. It speaks to the limits to the ambitions here in terms of just wiping out an industry versus just trying to generate some revenue off of it. Yeah, this move might not require as much CapEx at first as you might think. I mean, Amazon has, just to give you some of the numbers, over 200 fulfillment centers already, over 80,000 trucks, 100 cargo aircraft that it owns, and more. And it has excess capacity right now. And being able to fill that capacity cheaply

Starting point is 00:14:19 is a big advantage to getting this started. But the idea is by the time CapEx is needed, this will have been a proven business model. But on the other hand, FedEx and UPS have significantly greater capabilities when it comes to things like ocean freight, freight forwarding, and other critical areas of the process that Amazon would have to spend heavily on. So it is a really good question, the why now, why is this the optimal time to build this out? One thing I'd caution people on too is that the data center comparison is obvious with AWS. I don't think it is a great like for like though, because chips are chips, data center is data center. It's kind of just, if not commoditized, it is pretty close. With this, what we're talking

Starting point is 00:15:01 about is basically carving out a section of an Amazon warehouse for someone else's stuff. There are going to be some customers where that's very attractive, but GXL Logistics was one of the companies that was down almost 20%. What they are offering for a company like Apple is, we're going to run your own warehouse. We're going to manage your inventories. We're going to manage all of that in a dedicated facility. I can't speak for Tim Cook, but I doubt Tim Cook wants all of his inventory just piled into the back of random Amazon warehouses. Capacity where you have it matters, unlike data centers. I don't want to whistle past a graveyard here. I think there's a real threat to these companies, but I do think that it's going to be harder in practice than it

Starting point is 00:15:44 is maybe just with data centers and some of the other areas. I think these other companies can survive and thrive even with Amazon. Yeah. And it will also be an interesting topic to follow because perhaps we're being slightly market reactionary here, but obviously you hear shipping and logistics like, oh, they're going after Amazon and UPS. But there, and like I said at the top, there are dozens of companies in the supply chain and logistics, whether it's freight forwarding, whether it's ground transport, less than truck load trucking. This could be a in a lot of different sectors. And it'll be interesting to really drill down and to figure out who is going to be affected the most and how we can better invest in this.

Starting point is 00:16:24 This was a thing that came out yesterday, and I feel like this is something like a long-term deep study project that would be worth coming up for the next couple of months. Unfortunately, this is a 20-minute podcast, so we can't do that right now. And after the break, we're going to hit our mailbag. Hey, just a quick reminder. If you want to get your questions into us, we love answering them. You can email us at podcasts at fool.com. That's podcasts at fool.com.

Starting point is 00:16:47 i've been saying there's two requests but i feel like my laundry lists of requests for this are getting longer and longer but number one keep it foolish number two keep it relatively short so i can answer it on air and three we do have to remember we cannot give personalized advice so if you want to ask a question we can share our thoughts and opinions but please don't misconstrued anything that we say to be personalized advice for anybody asking any questions so with that guidance and disclosure whatever you want to say our email today comes in from Pranjal Suntar. I hope I pronounced that name right. I apologize if I got it wrong. And here's his question. Hi, Motley Fool team. I'm a regular listener to the podcast. I've been

Starting point is 00:17:27 having trouble executing or refining the strategy of letting the winners run, or just buying and holding through the ups and downs of the market. I'll take two examples to showcase his dilemma. I'm long-term bullish on two companies, Axon Enterprises, A-X-O-N, and Sterling Infrastructure, S-T-R-L. Both of them I've trimmed because I felt the valuation was too high. One I got right, one I probably got wrong. At times, valuation seems too high and feel like taking the gains, but you can lose the long run of these stocks and never get a re-entry if they continue to win. So any thoughts on how you guys like to manage this? Cheers. Matt, let's start with you. My short answer is the reasons for the profit-taking matter. So for example,

Starting point is 00:18:11 I've done this in the past if the valuation became too high and became too high of a percentage of my portfolio for comfort. So even though if it ends up going higher, in my case, it was Apple that I sold for that reason, it's not necessarily a bad move. But in general, I ask myself, is the higher valuation justified by the recent results? Do I believe in the ability of management to keep the growth story going? And above all, do the reasons I bought the stock in the first place still apply. So I don't necessarily think you make a bad move by trending, especially if you have valuation concerns, but it really depends on the specifics of the situation. Yeah. Sterling's up 47% last I looked today. That's brutal. And I get it. And I, I don't know if I've ever been

Starting point is 00:18:56 there where 47% up a day and oh no stock I sold, but it feels terrible. And I get that. I got to say though, taking profits to me is never a terrible thing. So I do try and appreciate the well, profit is good. I don't think there's a perfect formula. The closest thing is something Matt said is, is that I try and look at the reasons I bought in the first place and ask, are they still valid? And if they're still valid, I'm probably want to hold on. But if not, or if the thesis has played out or, you know, I just got lucky and the reasons I bought weren't the reasons that went up, maybe that's a reason to look elsewhere. That's really hard to do. It's a good reason to write down or at least remember the reasons you buy, whether you

Starting point is 00:19:38 journal something like that. But again, for me, I try to stay with something as long as I believe it, whether the stock is doubled in price or cut in half. And that's a lot harder in practice than it is to talk about. Yeah, I mean, there is no great answer to this, because if everyone knew exactly how to execute the letting your winners run strategy, I think we'd all be incredibly good at this and everyone would be rich and nobody would have to worry about asking questions like this. But this is really that intersection of the emotional aspect versus the rational aspect,

Starting point is 00:20:14 because valuation does have this very emotional component for it. How much am I willing to pay for growth? Or how much am I willing to pay for value? I mean, valuation, regardless the type of stock is going to come into it somewhere or the other. Sometimes valuation is less of a concern depending on the company, but it always is in the back of your mind. You see a large price gain and you're like, wow, can I really do much better? And to both Matt and Lou's point, it really depends. It depends on the growth trajectory of the business, whether they can maintain it for a long period of time and sustain it for years to come. If that's possible, then yeah, then letting your winners run is great. But if you start to look at the fundamentals of the business, perhaps

Starting point is 00:20:55 the thesis has changed. Perhaps the growth is slowing. It's a cyclical business. All of these things have to be considered. There is no tight, neat, perfect formula for any of this. And unfortunately, that's not the most satisfying answer for investors, but that's why it's hard. That's why we like to talk these things out. And that's why we like to answer your questions, because it makes it a lot of fun, interesting, and engaging. But that's all the time we have for today. And I want to thank Matt and Lou for sharing our thoughts. And I'm going to hit disclosure, and we'll get out of here. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for

Starting point is 00:21:30 or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our advertising disclosure, please check out our show notes. Thanks for producer Christy Waterworth and the rest of The Motley Fool team. For Lou, Matt, and myself, thanks for listening, and we'll chat again soon. you

Motley Fool Hidden Gems Investing - Shopify Retreats, Amazon Attacks

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.