Chewy stock (NYSE:CHWY) has experienced a never-ending plunge over the past three years, potentially entering deep-value territory. The one-stop specialty e-shop for all pet needs has seen its shares record a drawdown of 86.6% from its 2021 highs, achieving promising sales and profitability milestones during this period. There are definitely some risks that are worth considering attached to Chewy’s investment case. Still, the stock seems to offer great value at its current levels. Consequently, I am bullish on CHWY stock.
What’s Impacting Chewy’s Share Price in Recent Years?
In my view, the most significant factor contributing to Chewy’s share price decline in recent years is the persistent challenge the company faces in achieving meaningful profitability.
For context, the company’s adjusted EBITDA margin stood at 0.9%, 3.0%, and 3.3% at the end of FY 2021, FY 2022, and FY 2023, respectively. Regarding its net income margin, it came in at -0.8%, 0.5%, and 0.4% in each of these periods as well. This is despite revenues growing from nearly $9.0 billion in FY 2021 to $11.1 billion last year. Clearly, investors are discouraged by the fact that profitability can’t scale, even following robust revenue growth.
However, this is not Chewy’s fault. On the contrary, it’s a very common theme in the industry. You see, the pet industry operates on razor-thin margins because it’s brutally competitive.
First, consider that multiple brands focus on the premiumization and commoditization of pet foods to serve all kinds of consumers, meaning that pricing is very competitive. Second, because customers tend to stick with the brands they like, these companies are willing to spend a lot on customer acquisition. This mix explains why the pet food industry doesn’t have high profit margins. Thus, Chewy, being the retailer, also doesn’t really have room to charge a premium versus a competitor like Amazon (NASDAQ:AMZN).
Gradual Improvements Lead to Rising Free Cash Flow, Nonetheless
As I just illustrated, Chewy’s overall margins remain unattractive. However, the company has been taking advantage of the benefits of building a strong customer base online, including securing highly recurring cash flows. Along with expanding in other verticals that are likely to unlock higher revenue opportunities, Chewy’s free cash flow (FCF) should remain on the rise.
Regarding recurring cash flow, I am referring to Chewy’s Autoship program. It’s essentially a subscription service that allows pet owners to plan regular deliveries of pet supplies at their door. It’s convenient and saves consumers money, which is why Autoship sales accounted for 76.2% of Chewy’s total sales last year. This is higher than FY 2022’s 73.2% and FY 2021’s 70.5%.
The Autoship program’s perks aren’t just for consumers; they also greatly benefit Chewy. It essentially allows the company to optimize operations, manage supply chains more efficiently, and balance pricing to remain competitive without sacrificing margins. At the same time, Chewy’s expansion to other verticals should contribute to profitability. For instance, in 2022, Chewy launched Careplus, its product suite of Insurance and Wellness plans, which it further expanded in 2023 to make it even more comprehensive.
For these reasons, Chewy’s free cash flow has been on the rise, a trend that seems poised to continue. In FY2023, the company posted free cash flow of nearly $343 million, up from $119 million in FY 2022 and just $8.6 million in FY 2021. In the meantime, consensus estimates expect free cash flow to rise to $365 million in FY 2024 and further to $410 million in FY 2025.
Current Share Price Offers a Deep-Value Opportunity
Chewy’s growing free cash flow against the stock’s continuous decline has led to the current share price potentially offering a deep-value opportunity. At a market cap of $6.9 billion, Chewy trades at 18.9x this year’s expected free cash flow and 16.8x 2025’s expected FCF.
This multiple may not sound too compelling at first glance, but you have to consider that the pet industry is notorious for its sky-high multiples. Investment bank R.L. Hulett reported that the median EV/EBITDA multiple for strategic acquisitions reached 36.6x in 2023.
Given that Chewy could easily be considered a strategic acquisition target, having built a stronghold in the pet industry with highly recurring cash flow, I believe the stock’s forward price/FCF multiples signal a deep-value opportunity. It’s also worth noting that Chewy has a net cash position of $606.2 million, meaning that its growing free cash flow should easily compound the business’s overall equity.
Is CHWY Stock a Buy, According to Analysts?
Checking Wall Street’s view on the stock, Chewy has a Moderate Buy consensus rating based on 11 Buys, six Holds, and one Sell assigned in the past three months. At $22.84, the average Chewy stock price target implies 44.8% upside potential.
The Takeaway
Overall, Chewy’s share price performance over the past few years has been ugly. Nevertheless, the stock likely presents a deep-value opportunity at its current levels. Sure, the company’s margins remain razor-thin. Still, Chewy’s Autoship program and expansion into other verticals promise to strengthen its free cash flow, which I believe should allow the stock to attract a higher valuation multiple, moving forward.
