Chewy: Strong Results But Competition Is Stiff

May 18, 2022 4:08 AM ETChewy, Inc. (CHWY)AMZN, EBAY, EBAYL, GIS, NSRGF, NSRGY, SHOP, TGT, WMT16 Comments4 Likes
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Summary

  • Strong results in FY 2021 despite supply challenges, and receding pandemic-fueled tailwinds.
  • Long-term initiatives aim to increase wallet share, boost top line and margins.
  • Strong results so far, but competitive risks could dampen future results.

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Pet care online retailer Chewy (NYSE:CHWY) has grown in leaps and bounds over the past several years. Near term macro challenges are expected to weigh on performance this year, but longer term the company is working on several strategic initiatives to increase wallet share, boost revenues and margins. Competition however is extremely stiff which could dampen future growth. Some may view the stock as a hold while others may view the stock as a sell (given the high short interest).

Solid results in a year of tough comps, supply chain challenges

Like most other ecommerce players, pet-supplies ecommerce company Chewy was a beneficiary of a pandemic-driven online retail and pet adoption boom over the past two years with revenue growth accelerating during FY 2020 (financial year ended January 2021) to 47% YoY to USD 7.15 billion. Revenue growth decelerated in FY 2021 (year ended January 2022), however driven by active customers increasing 8% YoY to 20.7 million in FY 2021, and net sales per active customer (NSPAC) rising 16% YoY to a record USD 430, Chewy still notched a robust double digit growth rate of 24% YoY to USD 8.89 billion, a strong performance in a year of supply chain challenges and tough comps (most players in the online retail space reported decelerating revenue growth in FY 2021 due to tough comps, receding pandemic-related tailwinds, and supply chain headwinds among other reasons; Amazon’s (AMZN) FY 2021 revenue growth decelerated to 21.7%, Etsy’s (ETSY) FY 2021 revenue growth slowed to 35% YoY, Shopify’s (SHOP) FY 2021 revenue growth slowed to 57% YoY, eBay’s (EBAY) revenue growth slowed mildly to 17% YoY). Chewy’s FY 2021 revenues are 83% higher than FY 2019, representing a CAGR of more than 35%.

FY 2021 gross profits increased 30.5% YoY to USD 2.4 billion. Operating losses narrowed to USD 72.2 million and net losses dropped to USD 73.8 million.

Near-term headwinds: labor crunch, rising freight costs

Chewy has so far navigated near term challenges solidly; revenues have grown despite supply chain bottlenecks exerting pressure on out of stock levels and therefore sales, gross margins have expanded despite rising outbound freight costs pressuring margins (the company’s gross margins expanded to 26.7% for FY 2021, a new company high) and operating losses have narrowed to ( from (1.27%) in FY 2020 to (0.81%) in FY 2021) despite rising wage and recruitment costs contributing to upward pressure on full-year operating expenses.

Going forward near term challenges are expected to continue with management expecting a 100-150 basis point impact on gross margins due to rising outbound freight costs (their new outbound shipping contract with FedEx went into effect in January this year the impact of which is expected to show up in 2022). To mitigate the impact on margins, management has launched supply chain and logistics initiatives to lower freight costs (such as opening multiple automated fulfillment centers, four are planned for 2022), and accordingly expects FY 2022 margins to be broadly similar to FY 2021.

Market growth and long-term strategies may contribute to top-line growth and margin expansion

Pet ownership increased during the pandemic, and a growing pet population along with pet humanization is driving the overall pet care industry which is expected to see robust growth in the coming years. A number of players have moved into the pet care space; food giants Nestle (OTCPK:NSRGY) and General Mills (GIS) have moved into pet food with stellar results, and while retailers including Amazon, Target (TGT), and Walmart (WMT) have been ramping up their pet care offerings. The trend is a positive for pet care-focused online retailer Chewy who had already been reporting very strong top line growth, even before the pandemic.

Chewy revenues

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Chewy, already a major player in the online pet supplies retailing space, has been working on several strategic initiatives to capitalize on this growth opportunity. Since 2016, the company has launched a few private label brands - pet products brand Frisco, and pet food brands American Journey, and Tylee’s. Private label brands generally tend to have higher margins and Chewy’s ambition to grow these brands could help support margin expansion going forward.

Two new businesses are expected to be launched in 2023. The first, Chewy Loyalty, a customer membership program which could increase customer “lock in” and switching costs. And second, sponsored ads on the Chewy platform, an additional revenue stream that could not only help drive NSPAC but could also be potentially margin accretive too.

Pet healthcare is another strategic focus whereby Chewy aims to grow its pet health related services such as telehealth, medications, and pet insurance.

Competitive risks

The pet care industry is extremely competitive and Chewy is competing against several bigger, more experienced, and well-established players jostling for a share of the booming market. Online retail giant Amazon, Chewy’s biggest competitor, is aggressively moving to take a bigger bite out of the fast-growing pet care segment. The company recently launched its first Amazon Pet Day sale this month which offers pet parents savings on home, pet, and pet-focused toys and electronics. The ecommerce juggernaut has also pushed out a slew of other pet-related goodies from pet profiles, recommendations and coupons for their pets, and additional rewards for pet parents who are Prime members and Amazon Prime Rewards Signature Card holders. Like Chewy, Amazon jumped into the pet food space with its own pet-focused private label brand, Wag, launched in 2018 and currently offers an extensive range of products.

Amazon, already wielding a market leading position (market research figures put Amazon as the market leader in the U.S. online pet supplies retailing space with a market share of 59%, considerably ahead of second-placed Chewy with a market share of 41%, and Walmart (33%)) has considerable competitive advantages including years of experience in the ecommerce space, and gigantic pockets, and Chewy might struggle to compete.

Other noteworthy players include Walmart, which added in-store vet clinics in 2019, and launched a full-service, omnichannel pet care offering which includes pet insurance, pet sitting and dog walking services - Walmart Pet Care - in 2020, carried on the momentum in 2021 with the launch of a veterinarian-formulated pet food product line under its private label pet food brand - Pure Balance.

Meanwhile Target launched Kindfull - a new premium private-label pet-food line last year, joining Boots & Barkley (Target’s private label apparel and accessories brand for pets).

While Amazon has the advantage of unrivaled scale and variety, big-box retailers like Walmart and Target have the advantage of offering an omnichannel offering which not only offers marketing and customer service advantages but operational and logistics advantages as well. Online-only retailer Chewy currently has certain competitive strengths such as its online pet pharmacy (which has generated solid results growing 75% YoY in Q4 2021, and tripling over the past 2-3 years) and Connect with a Vet service (Amazon does not as yet have an online pet pharmacy, while Walmart does, but both don’t offer a service comparable to Chewy’s "Connect with a Vet" telehealth service which is available for free to subscribers of Chewy’s Autoship automatic replenishment program), however it is not impossible for rivals to emulate and offer a similar service.

Financials

Since its founding in 2011, Chewy has yet to turn a profit, however the company has been consistently improving its profitability with gross margins, operating margins, and net margins consistently trending in a positive direction.

Chewy gross margins, operating margins, net margins

Author

Operating cash flows have also trended upwards.

Chewy operating cash flows

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Summary

After a strong run over the past two years thanks to a pandemic-fueled boom in ecommerce and pet adoption, Chew’s stock has been dropping since 2021 following a broader selloff in the online retail space. Chewy’s stock is down 62% over the past year, and still has a massive 25% short interest.

Chewy short interest

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Near term challenges including elevated out of stock levels as a result of supply chain bottlenecks and cost inflation are expected to continue weighing on performance, with Chewy expecting a slowdown in revenue growth to about 15%-17% YoY reaching USD 10.2 billion - USD 10.4 billion and broadly similar margins in 2022.

Longer term the company is implementing several strategic initiatives to grow wallet share including expanding pet health offerings and growing its private label products. These initiatives could help Chewy increase wallet share and grow NSPAC (at USD 430 there is ample room for growth considering about USD 1,200 annual average spend in the U.S. per pet household) and thereby contribute to top line growth and margin expansion however much would depend on execution as stiff competition from well entrenched incumbents with greater scale and deeper pockets may make the smaller player’s ambitions an uphill climb.

Analysts are largely split between a buy and a hold.

Analyst ratings - Chewy

WSJ

This article was written by

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Long only, focused on high quality businesses with economic moats and solid business fundamentals. Sector and geography agnostic. Long term investment horizon. None of the articles constitute investment advice.
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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.

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