Why Chewy’s (CHWY) Run is Overdone

Americans spent $147 billion on their pets in 2023.

66% of U.S. households own a pet.

Naturally, you’d expect a well-liked company like Chewy (CHWY) to do well.

And they did for a while.

After years of remarkable success, the company’s sales growth has slipped below 10% annually.

That prompted investors to send shares below $20 in late 2023, where they remained until recently.

After the company’s May earnings report, shares leapt, topping out at $40, buoyed by the company’s stock buyback announcement.

Shares have retreated below $30 but have held a good chunk of those gains.

Financial pros have been eyeballing the stock since the announcement, making it their top speciality retail stock search according to our TrackStar data.

After looking through the company’s financials and future prospects, we feel the stock trades at an unnecessary premium.

Here’s why.

Chew’s Business

Chewy is an e-commerce powerhouse in the pet products industry, offering a vast selection of pet food, supplies, and healthcare items. 

Founded in 2011, the company has quickly become a go-to destination for pet parents. It differentiates itself through exceptional customer service and a comprehensive product range.

Operating primarily online, Chewy provides a convenient one-stop shop for pet owners across the United States. The company’s product lineup includes over 115,000 items from approximately 3,500 brands, ranging from food and toys to medications and pet insurance. 

Chewy’s Autoship subscription program automatically delivers recurring orders and has become a cornerstone of its business model, accounting for a significant portion of sales.

The company segments its business into the following areas:

• Consumables (71% of total revenues) – Includes pet food, treats, and other everyday pet supplies
• Hardgoods (11% of total revenues) – Encompasses durable goods such as pet furniture, toys, and accessories
• Other (18% of total revenues) – Comprises healthcare products, services, and other pet-related offerings

In its most recent quarter ending April 28, 2024, Chewy reported net sales of $2.88 billion, a 3.1% increase year-over-year. 

Gross margins expanded to 29.7%, up 130 basis points from the previous year. Notably, Chewy announced its first share repurchase program of up to $500 million, signaling confidence in its financial position and future prospects.

The company recently expanded into veterinary care with the opening of its first four Chewy Vet Care clinics, marks a significant step in diversifying its offerings and deepening its relationship with pet owners. 

This move into physical locations complements the company’s strong online presence and could pave the way for future growth opportunities in the pet healthcare sector.

Financials

Source: Stock Analysis

Chewy’s sales grew rapidly through 2022. Then things slowed down as the post-pandemic bounce faded and the company started to hit market saturation levels.

During that same period, margins improved slightly, with profitability turning positive with free cash flow climbing.

Since the company doesn’t carry much debt, it’s used the latest windfall to institute a share buyback program.

Valuation

Source: Seeking Alpha

Like many high-growth companies, Chewy’s GAAP P/E ratio doesn’t truly reflect its value.

When we compare its non-GAAP P/E ratio and price to cash flow ratio to its peers we find it more expensive than every other stock save Restoration Hardware (RH). This implies investors expect high sales growth to continue.

Growth

Source: Seeking Alpha

In reality, Chewy’s future sales prospects are dim compared to its past.

After years of +10% YoY growth, its forward outlook is just 6.9%. Interestingly, that’s the second best to Pinduoduo (PDD).

Much of this may be tied to lower consumer spending that economists are forecasting for 2024.

Profitability

Source: Seeking Alpha

One of the biggest drags on Chewy is its profitability.

Not only are its margins some of the lowest, but its free cash flow margin is the second worst, just behind Restoration Hardware.

That’s largely why its returns on assets and total capital are so poor.

Our Opinion 4/10

Chewy’s stock is valued like a growth stock…except it’s lacking growth.

Given its market saturation and lower consumer spending, we feel it’s overpriced at these levels.

In our estimation, a better valuation puts it back below $20 per share.

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