Chewy Inc. (CHWY, Financial) is the largest pure-play retailer of pet products in the U.S.
Through its website and mobile applications, customers can choose from more than 110,000 pet-related products and services, including food, medications and toys. Chewy also manufactures and sells products via four private label brands. Roughly two-thirds of annual sales are auto-subscription based. The pet care industry is very attractive as pet owners are usually highly dedicated towards the welfare of the their pets since they are a big part of people's lives.
Chewy completed its initial public offering on June 13, 2019. At that time, 46.50 million shares were sold to the public at an average price of $22 per share. In spite of tremendous ramp up in sales, the stock is currently selling at a price not too far above its IPO price. It is controlled by U.K.-based private equity firm BC Partners. Baillie Gifford (Trades, Portfolio), a U.K.-based growth-oriented asset manager, owns 13.76% of the stock.
Expansion and performance
The company has started its international expansion and is set to enter Canada this year, starting with the Greater Toronto area. It has also competed its fourth automated fulfillment center in the U.S., in the Nashville area. Revenue has grown rapidly over the last three years (clocking in at a 34% annualized rate over the last five years) and the company had turned profitable on a net-income basis. Currently all its sales are U.S.-only. I expect profitability to ramp up rapidly in the next few years.
Gross margins have been improving, net margins and operating margins have turned positive. This trend should continue.
Fiscal Period | Dec 16 | Jan 18 | Jan 19 | Jan 20 | Jan 21 | Jan 22 | Jan 23 | TTM | |
| Gross Margin % | 16.64 | 17.47 | 20.23 | 23.6 | 25.48 | 26.7 | 28.03 | 28.26 | |
| Operating Margin % | -11.93 | -16.06 | -7.58 | -5.21 | -1.27 | -0.81 | 0.55 | 0.58 | |
| Net Margin % | -11.9 | -16.07 | -7.58 | -5.21 | -1.29 | -0.83 | 0.49 | 0.51 | *Profits* |
However, the stock is still building a base and has not responded to the continued execution by the company. Further, the stock market still does not appreciate its operating leverage. This leads me to believe it may be a good time to establish a position in this pet care e-commerce leader. While Chewy competes with several other e-commerce and brick-and-mortar retailers, including giants like Amazon (AMZN, Financial) and Walmart (WMT, Financial) and the numerous specialized pet stores, and e-commerce sites, what distinguishes it is its focus on customer service, specialization on pets and personalized marketing.
Chewy also has an insurance and telehealth segment. It offers a "Connect With A Vet" service as well as a pet pharmacy. Moreover, last year, the company rolled out a "CarePlus" pet insurance plan and recently bolstered it through a new partnership with Lemonade's (LMND, Financial) pet insurance segment. It is building out a more comprehensive pet offering than what can be offered by larger operators like Amazon, Walmart and Costco (COST, Financial), who sell almost everything under the sun.
Valuation
Its tough to evaluate Chewy because it is still in the build-out phase and profitability is just starting. Analysts are expecting rapid ramp-up of earnings as operating leverage kicks in. The Value Line investment service puts an 18-month price target of $60. Morningstar analysts, on the other hand, are less optimistic and give a fair value of $42. CFRA's analyst 12-month target is $40. However, all these targets are well above the current price of $27.50, thus indicating a wide margin of safety. GuruFocus is also flagging the stock as significantly undervalued. The GF Value is an intrinsic value estimate that uses the stock's historical price multiples, past returns and estimates of future business performance.
| Growth Rates (Per Share) | Annuals (Year End) | Analyst Estimate | ||||||
| Fiscal Period | 5-Year | 1-Year | Jan 21 | Jan 22 | Jan 23 | Jan 24 | Jan 25 | Jan 26 |
| Revenue | 34.70% | 11.60% | 7,146 | 8,890 | 10,098 | 11,527 | 12,547 | 14,032 |
| EPS without NRI | - | - | -0.23 | -0.18 | 0.12 | 0.35 | 0.43 | 0.77 |
The GF Score is a stock performance ranking system developed by GuruFocus using five aspects of valuation, which has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021. A look at the GF Score reveals strong financial strength and growth, but poor profitability and value. However, profitability is improving and value should follow.
Conclusion
Looking at the positive aspects, Chewy's presence in the e-commerce sector focused on pet care is poised to grow further. This trend is particularly advantageous for digital-first companies like Chewy. Leveraging its subscription-based model (with around 75% automatic shipping adoption), the company is well-positioned to retain the bulk of customers it acquired since the start of the Covid-19 pandemic. Interestingly, around two-thirds of its customer base are also members of Amazon Prime. This suggests the potential competition from the giant e-commerce platform might not be as damaging as some may expect.
However, on a less upbeat note, Chewy could encounter challenges in sustaining its growth within the pet health prescription and over-the-counter drug markets. This could occur if veterinarians are hesitant to fulfill prescriptions through Chewy's platform, instead preferring to generate profits from prescriptions through their own dispensaries. Unlike human medicine, medical doctors' conflict of interest rules do not apply to veterinarians.
Further, the pet food category exhibits robust brand loyalty, which raises concerns about Chewy's vulnerability due to its concentration on a few suppliers. Specifically, relying on its top three suppliers for a third of its sales poses a potential risk. This also limits its flexibility to expand its private label offerings and forces it to operate on thin margins.
When considering expansion into international markets like Canada and beyond, Chewy may encounter difficulties based on the history of other consumer companies' failed attempts. Notable failures like Best Buy (BBY, Financial) and eBay (EBAY, Financial) in China, Walmart in South Korea and Target (TGT, Financial) and Nordstorm (JWN, Financial) in Canada underscore the uncertainty of achieving significant success when taking the Chewy brand abroad, where the business model may not resonate.
At the present time, Chewy stock appears to be showing weakness, thus I recommend waiting until the technical picture improves and the short-term moving average (i.e., 20-day SMA) starts to point upward.
In summary, Chewy has high growth potential with an excellent balance sheet and presents a good opportunity at this current price level for investors to get an entry into this fast-growing and attractive category.
