Stock Analysis & Ideas

Chewy Stock: Ample Room for Growth Despite Short-Term Challenges

Story Highlights

Chewy stock has declined 40% this year along with the sell-off in tech stocks, but the company reported a surprise profit for the first quarter despite several macroeconomic challenges. Chewy is tapping into new market opportunities to sustain growth, which should entice growth investors to consider the company.

Chewy, Inc. (CHWY), the pet supplies e-commerce giant, reported a surprise profit for the first quarter of 2022 along with better-than-expected revenue on June 1, leading to a surge in its stock price. However, Chewy stock is still down more than 40% this year amid macroeconomic challenges that threaten the growth of tech companies.

Despite many reasons to be cautious, Chewy seems to enjoy a long runway for growth resulting from the promising long-term outlook for its business. I am bullish on Chewy, although the company may not be a short-term winner in the stock market.

On TipRanks, CHWY stock scores an 8 out of 10 on the Smart Score spectrum. This indicates moderate potential for the stock to outperform the broader market.

The Promising Industry Outlook

The pet industry flourished during the past two years, driven by the pandemic-induced mobility restrictions. The demand for pet adoption does not seem like cooling off, contrary to the earlier projections for a notable decline in demand in the post-pandemic era.

According to research conducted by Global Market Insights Inc., the global pet care industry is expected to grow at a 6.1% compounded annual growth rate to $350 billion by 2027.

The industry has also proven its resilience during recessions due to pet humanization. Therefore, compared to other e-commerce platforms that primarily focus on consumer discretionary products, Chewy seems to be in a good position to negate some of the challenges resulting from 40-year high inflation. Pet care spending grew by 29% during the 2001 recession and 17% during the 2008-2009 recession, which confirms this thesis.

Survey results compiled by the American Pet Products Association indicate that during the post-pandemic era, 22% of pet owners plan to purchase products online, which is double the pre-pandemic rate, although it is a marginal decline compared to the number of consumers willing to buy pet products online at the height of the pandemic.

Going by these numbers, it would be reasonable to expect sustainable demand for Chewy’s products in the foreseeable future.

Recent Financial Performance and New Growth Strategies

Chewy’s active customer base grew 4.2% year-over-year to 20.6 million in the first quarter, although growth remained flat on a quarter-over-quarter basis. The majority of Chewy’s revenue is derived from the subscription business, which allows customers to preschedule orders and get them delivered to their doorstep.

In the first quarter, Autoship customer sales increased to 72.2% of net sales from 69.3% in 2021, which is a record high for the company. Net sales per average customer increased 15% to an all-time high of $446.

According to the company, customers spend less than $200 in their first year, more than $400 in their second year, and $700 by their fifth year, and the oldest cohort spends nearly $1,000 per year, which is a trend that needs to be considered when analyzing the company.

With two-thirds of active customers gained within the last three years, the company is yet to unlock the true revenue potential from the bulk of its customers.

Chewy strengthened its supply-chain operations in Q1 through new outbound freight contracts, which improved on-time delivery to customers by 8% compared to Q4 2021. With this, Chewy’s gross margin expanded by 210 basis points sequentially.

The improved margins translate to a negligible decline of 10 basis points on a year-over-year basis, which is impressive considering the substantially higher raw material costs the company is seeing today.

Chewy intends to launch a wellness plan that covers preventive care, such as annual exams, vaccines, routine lab tests, parasiticides, and insurance plans, which offer protection against accidents, unexpected illnesses, and surgeries for pets.

The company also plans to offer a telehealth service to connect with a vet as an additional benefit to insurance customers and 100% reimbursement after deductibles for medicine purchased from Chewy Pharmacy. Customers have the option of purchasing both plans together to look after their pets in the best way possible without breaking the bank.

According to the National Association of Insurance Commissioners, approximately 68% of U.S. households own a pet, whereas a mere 2% own insurance for their pets.

A recent Lending Tree Pet Survey revealed that 47% of pet parents carry some pet-related debt. Since pet owners consider pets as a part of their family, the well-being of the pets is an essential factor for them, which is why there is a higher tendency of owners to opt for insurance instead of cutting down expenses.

The pet insurance market has grown by double digits for six consecutive years, and the Society for Human Resource Management estimates that about 15% of employers in the U.S. offer pet insurance benefits, which highlights the long runway for growth available for Chewy with its insurance product.

According to data from Google, searches for the term “pet insurance” are at an all-time high these days, which serves as a definitive sign of the high demand that could be expected for pet insurance products in the future.

Wall Street’s Take

Based on 18 Wall Street analysts offering 12-month price targets for Chewy, the average Chewy price target comes to $49.67, which implies upside potential of 26.7% from the current market price.

Takeaway

Chewy stock has found it difficult to gain traction this year, with investors moving away from tech stocks to focus on companies that could potentially weather an economic recession better than most tech companies.

Chewy, however, operates in an industry that is likely to show strong resilience to a recession, and the company is tapping into new markets that offer growth opportunities. Although Chewy may not prove to be a winner in the short run, the company seems well-positioned to perform well in the long run.

Disclosure

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