Stock Analysis & Ideas

Has Chewy Lost its Bark for Good?

Following Chewy’s (NYSE: CHWY) results for the fourth quarter of fiscal 2021 after the markets closed on March 29, share prices have been in free fall, losing about 14% of their value by market open on Wednesday.

What Went Wrong in Q4?

Apart from reporting the third straight quarter of losses, the revenues generated by the online retailer of pet-care products fell short of both Wall Street expectations, and its own guidance. Moreover, a dismal guidance for the fiscal year 2022 did not sit well with investors. The company expects annual revenues this fiscal year to be between $10.2 billion to $10.4 billion, which is below the consensus estimate of $10.8 billion. Apart from being lower-than-expected, the guidance also highlights the decelerating growth of the company.

Chewy was one of the companies which had significantly benefited from the pandemic, when the stay-at-home orders sparked the entry to pet ownership for multitudes of households. Despite the fact that pets can be considered an annuity for firms like Chewy, the reopening of the economy did not bode well for the demand for its products.

Moreover, supply-chain issues still hang heavy on the company’s operations. In a recent letter to shareholders, management indicated that the company is struggling with “conflict between the fundamentally strong consumer demand that underpins our business and the highly challenging operating environment.”

Increased inbound freight costs, labor expenses, and product costs made it difficult for the company to be profitable in the recently reported quarter.

Management also mentioned that the emergence of Omicron in the middle of the fiscal quarter made things difficult in an already precarious supply-chain situation.

Experts Concerned

The print was followed by a flurry of price target slashes by analysts. UBS analyst Michael Lasser, who is also among TipRanks’ five-star rated analysts, cut his price target to $42 from $46 while reiterating a Sell rating on Chewy. Despite management mentioning positive trends seen during Q4 with regard to site traffic, conversion, order volumes, and basket size, Lasser noted that Chewy fell behind his revenue growth estimate by 1.4%.

The analyst was also discouraged by the weak cohort retention during the quarter. For the unversed, cohort retention percentage is the number of active users from a particular group in a day, as a percentage of the number of users in the group on the first day of the period under consideration.

Apart from Lasser, Morgan Stanley analyst Lauren Schenk slashed the price target on Chewy to $62 from $68, while maintaining a Hold rating, arguing that Chewy’s “’22 guide implies it will have added $5.5B in revenue over the last three years but only around $185M in incremental EBITDA dollars,” which is making investors question whether this model can generate more than a low single-digit EBITDA margin in the long-term, especially since gross margins are already under pressure from high variable costs.

Schenk reiterated her long-documented concerns about Chewy’s business flow-through rates (the portion of additional profit from every incremental dollar of revenue recorded in comparison to the previous year’s revenues, which is included in the bottom line). She noted that the inflation and cost elevations stemming from the supply-chain pressures are further aggravating this issue.

Also among the Chewy bears is Barclays analyst Trevor Young, who trimmed his price target to $41 from $43 while keeping a Hold rating. The lower-than-expected margin and weak guidance were among Young’s biggest concerns, and he prefers to remain quiet until he can more confidently see customer growth improvement and lower gross margin pressure in his outlook.

Wall Street consensus is cautiously optimistic about Chewy, with a Moderate Buy rating, based on 10 Buys, six Holds, and one Sell. The CHWY price prediction indicates an average price target of $64.50, a 44.1% upside from the Wednesday’s opening price levels.

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