Chewy: Fairly Valued

Summary

• The pet industry is expected to triple by 2030 and Chewy is set up perfectly to capitalize on that growth.
• CHWY will need to reinvest at high dollar amounts to fully capture its growth potential.
• Chewy is valued fairly in the market as my DCF model currently values Chewy near $55/share.

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Chewy, Inc. (NYSE: CHWY) is significantly larger than the typical company that I investigate (~$20B Market Cap), but my Dad works in the pet industry and has been pounding the Chewy drum for a while now. As a contrarian value investor, my response has always been, "sure, it's a great company with a great service, but can you buy it at a good price?". This question has no real answer (although much debate) as my Dad isn't trained to value businesses. So recently, I decided that I've heard enough about Chewy and decided to end this conversation by valuing the company myself.

So here ya go, Dad; this is how much Chewy is worth.

Business Overview

Chewy is in the internet retail business and specifically sells just about any pet product that your pets could ever want. The company competes with traditional brick and mortar pet supply companies such as PetSmart and PetCo (WOOF). Chewy is also in direct competition with Amazon (AMZN), which everyone knows sells everything... and that category is broad enough to include pet supplies. Chewy is currently only retailing in the US but has a 40% share of the online pet supply market, trailing only Amazon in that category.

Outlook

Chewy has performed very well in the past couple of years, growing overall revenues 32% CAGR since 2018. This was due to growth in the pet industry combined with a little lighter fluid called COVID-19. During the pandemic, CHWY has grown revenues $1.3B and $2.3B in 2020 and 2021, respectively. Additionally, analysts expect CHWY to have about $8.92B in revenues for 2022.

Source: Author Created using data from Seeking Alpha

Moving forward, Chewy should also be a significant beneficiary of the overall expectations of the growing pet industry. According to Morgan Stanley, in the US,

“The $100 billion pet industry is poised to nearly triple to $275 billion by 2030 thanks to a surge in new owners, favorable demographics and increased per-pet spending.”

Globally, the pet industry is currently about $232B in total and is expected to be $625B by 2030. In addition, Statista stated that

"In 2020, approximately a fifth of global household and pet care sales was generated through e-commerce, while the remainder was made in-store. Starting from roughly ten percent in 2015, worldwide e-commerce sales have increased with each consecutive year, and are estimated to reach about 30 percent by 2025."

Currently, Chewy holds a 40% market share in the US but is not selling globally. CHWY has stated that they are focused on expanding their US customer base and sales per customer by adding new product lines. In 2019, the company said it plans to expand globally in one to five years, so we can expect Chewy to attempt to gain traction globally within a couple of years.

According to Cardify.ai, CHWY has a net promoter score of 60%, which is over 20% higher than PetSmart and PetCo. A high score above its peers tells me that CHWY has a strong brand which should lead to more consistent sales and higher margins in the future.

Value/Assumptions

With all of the favorable tailwinds and growth potential for Chewy, I have an optimistic outlook on the direction of the company.

So, let's get down to the valuation. Here are the assumptions that I have made in order to value Chewy:

• Chewy currently has a 40% US market share in the online pet supplies market, a margin that I hold constant in perpetuity. Additionally, Chewy will enter the global market in 2024 and gain a 20% market share outside of the US by 2030.
• CHWY will sell ~$33B in the US and ~$20B in the rest of the world by 2030
• Chewy's strong brand name will lead to slightly higher operating margins than the industry average (~8%).

Source: Author's Work

As you can see, my DCF values CHWY at $54.77/share (or ~22.9B market cap), which is near the current trading price of ~$44/share.

Risks

The main risks that I perceive with my valuation of CHWY are that growth could slow more than expected, the company enters the global market later than I have projected, and/or is not successful as a worldwide online retailer. Much of what is projected in my DCF hinges on Chewy becoming a major global player in the online pet supplies industry. If this is not realized, then there is a high likelihood that my terminal revenue figure and terminal value will be too high.

The margins that I have set are another possible risk. If Amazon or another retailer gains more traction (especially globally) than Chewy, then operating margins of 8% might be too high.

One significant business risk that I perceive is that a lack of warehouse space could slow growth. The #1 capital expenditure/reinvestment that Chewy will have to make in the future will be obtaining enough space to store pet supplies for resale.

The last risk with Chewy is its ability to issue more shares to fuel growth. Currently, Chewy cannot generate enough free cash flow to continue growing at high growth rates. Therefore, the company will need to tap into the capital markets to raise more cash.

Bottom Line

In my estimation, the market is currently valuing Chewy fairly, and I place a Hold rating on the stock. Although as shown above, I am bullish on the company.

And there you are Dad, Chewy is valued at roughly $22 billion, which is very similar to its current trading levels. And now we can stop wondering if Chewy is valued appropriately in the marketplace (until my Dad becomes even more bullish than me...).

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.