Chewy’s performance hasn’t been great. YTD the stock price is down -28%. At one point in May, it was down -58%. But, we're putting this name on our swing long ideas radar. It's not at the buy point as yet, but we're putting in alerts.
So what’s changed?
The last quarters has see a definite improvement in the Company’s financial metrics.
EPS growth is positive, and the company continues to grow revenues.
As with all other online, high-beta stocks, Chewy has also taken a beating in the market. Not surprising. The Company was bid up to insane multiples and that, we believe, is now normalizing.
The company continues to grow their Free Cash Flow and employs strategies for drive efficiencies. They have leases on the books but are completely debt-free.
We understand that the Consumer Discretionary category will come under pressure (see Macro section below). We also understand that online spending will slowdown (see Risks below). However, Chewy’s doing quite a good job in maintaining and growing wallet share. If you can’t increase the number of customer’s the second best option to grow, is always to take share away from others.
The Company continues to launch new offerings such as insurance and wellness to drive wallet share.
According to the company, a customer in Year 2 tends to spend $400 per year, $700 in Year 3, and $900 in Year 4.
Rising customer engagement as measured by net sales per active customer or NSPAC which grew nearly 14% to $477.
Chewy’s Autoship Program, which as the name suggests automatically puts in orders, increased 19% to 73.3% of Net Sales. These sales are predictable.
Gross Margin improved by 2% or 200bps year on year. 100bps was driven by reduced freight costs while the remainder was from shipping improvements, which is likely to be sticky going forward.
Enhanced software and logistical automation (now 30% of volume) added to improving margin at operating levels as well.
We’re not very happy with the Consumer Discretionary sector. In fact, we understand that discretionary spending is likely to take quite the hit in the coming quarters in addition to it’s dismal performance during the year. XLY (SPDR ETF Consumer Discretionary) is down -47.3% YTD.
However, spending in the Pet Care category transcends discretionary. Some of the spending is in fact, staples - food, insurance, medicines and basic necessities. The Pet Care industry is also slated to see massive growth over the next few years and Chewy stands to benefit from that. A few stats:
The pet industry is expected to reach $358.62 billion by 2027.
There are over 630 different pet food brands.
Americans spend $103.6 billion on pet products per year.
Pet industry spending has increased 115% since 2011.
86% of pet owners shop for their pet online.
We see some pressure in the industry for 2023 but, pet care is still likely to fare better among the discretionary sector.
This valuation is from Morgan Stanley. I use it because I agree with the upside calculation of the price target.
This price target assumes:
Chewy grows revenue at a 13% FY21-FY26 CAGR, sees stronger than expected net customer additions coupled with growth in net sales per active customer. The company accelerates traction in new verticals such as private label, expands its healthcare offering (pharmacy, telehealth, and pet health insurance), and sees a strong rebound in hardgoods, resulting in higher revenue and long term EBITDA margins of 13%.
Broker Ratings: Overall rating still a buy with more moving to hold and some moving to sell. The Average Price Target is $44.14. (Data from FactSet)
Every investment is a calculated risk, and for every potential upside, there’s a possible downside. Potential risks for Chewy:
The main concern with Chewy is the slowdown in sales growth. Ecommerce continues to experience customer churn while they “normalize” from pandemic levels and Chewy will quite likely get caught in this cycle.
Management noted the hardgoods is impacted both by the consumer mindset (discretionary spending) and the fact that lapping the pandemic boom pet households are flat to down at the moment. However, 83% of sales continues to be driven by food and healthcare (the more staple items).
Q4 may not see a great quarter as the holiday season will be driven by discounting. Pet households are also not likely to increase in the next two quarters. So the thesis will be driven by wallet share and margin improvement.
Chewy has an impending management change. They’ve announced the retirement of their CFO who will step down at some time in 2023 (date to be announced)
When I compare Chewy to what could be their closest competitors, I find that the company is doing relatively better than the others. The numbers are far from great but, they're on the right trajectory.
The company just reported earnings last week and this gave them a bit of a boost to today’s price of $42.40. If we see further pressure in the overall market, we’re like to see the stock price pull back to below $40. That’s where I would look at buy. The 50-day moving average has also crossed over the 200-day and the stock is displaying relative strength.
Mayhem says: Possible entry at $38.25-$38.50
Exit:
I would look for an upside profit of $50 for a swing trade of say 3-6months, however, you could take profits wherever you feel comfortable. I would also suggest a stop loss at 5%, to manage risk.
Mayhem says: Possible Exit at $49.15 with a hard stop on a close below $37.5 and a trail stop at -5%
Disclaimer: This is not investment advice. We have no position in this stock but, we may initiate a position 72 hours after the publication of this article.
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