Chewy is on the cusp on Profitability

Chewy, Inc. (

CHWY, Financial) is the largest pure-play retailer of pet products in the United States. Through its website and mobile applications, customers can choose from more than 110,000 pet-related products and services, including food, medications, and toys. Chewy also manufactures and sells products via four private label brands that it owns. Roughly two-thirds of annual sales are auto-subscription based.  The pet care industry is very attractive as pet owners (a.k.a. Pet parents) are usually highly dedicated towards the welfare of the their pets.  Pets are a big part of people’s lives and they give them great joy in their lives and pet owners in turn spend a lot of money looking after them.  Chewy, completed its initial public offering on June 13, 2019.  At that time, 46.50 million shares were sold to the public at an average price of $22.00 per share.  In spite of tremendous ramp up of sales, chewy is currently selling at a price not too much above IPO.  Chewy is controlled by UK based private equity firm BC Partners.  Ballie Gifford a UK based growth oriented asset manager owns 13.76% of the stock.

Chewy has now started its international expansion and is set to enter Canada this year starting with the Greater Toronto area .   It has also competed its fourth automated fulfillment centre in the US, in the Nashville area.   Revenue has grown rapidly over the last 3 years (clocking in at a 34% annualized rate over the last 5 years) and the company had turned profitable on a net-income basis.  Currently all its sales are US only.  I expect profitability to ramp up rapidly in the next few years.

CHWY Data by GuruFocus

 Gross margins have been improving and operating margins have turned positive.  This trend should continue.

 However the stock is still building a base and has not responded to the continued execution by the company and the stock market still does not appreciates the company’s operating leverage.  This leads me to think that this may be a good opportunity to establish a position in this pet care e-commerce leader.  While Chewy competes will lots of other e-commerce and brick & mortar retailers including giants like Amazon and Wal-Mart and the numerous specialized pet stores, and e-commerce sites, what distinguishes Chewy is its focus on customer services, specialization on pets and personalized marketing.

Chewy also has an insurance and telehealth segment. They offer a “Connect With A Vet” as well as a pet pharmacy. Moreover, last year the company rolled out a “CarePlus” pet insurance plan, and recently bolstered it through a new partnership with Lemonade’s (LMND) pet insurance segment.   Its building out a more comprehensive pet offering than what can be offered by larger operators like Amazon, Wal-Mart and Costco who sell almost everything under the sun. 

Its tough to valuate Chewy because its still in the build out phase and profitability is just starting.   Analysts are expecting rapid ramp up of earnings as operting leverage kicks in.  The Value Line investment service puts an 18-month price target of $60.   Morningstar Analyst on the other hand is less optimistic and gives a fair value of $42 and CFRA’s Analysts 12 month target is $40.  However all these targets a much above the current price of $27.50, thus indicating a wide margin of safety.   Gurufocus is also flagging the stock as significantly undervalued.  The GF Value is an intrinsic value estimate from GuruFocus that uses the stock’s historical price multiples, past returns and estimates of future business performance.

The GF Score isa stock performance ranking system developed by GuruFocus using five aspects of valuation, which has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021. A look at the GF score reveals strong financial strength and growth but poor profitability and value.  However profitability is improving and value should follow.

Looking at the positive aspects, Chewy’s presence in the E-commerce sector focused on pet care is poised to grow further. This trend is particularly advantageous for digital-first companies like Chewy. Leveraging its subscription-based model (with around 75% automatic shipping adoption), Chewy is well-positioned to retain the bulk of customers it acquired since the start of the COVID-19 pandemic.  Interestingly, around two-thirds of Chewy’s customer base are also members of Amazon Prime. This suggests that the potential competition from the giant e-commerce platform, Amazon, might not be as damaging as some may expect.

However, on a less optimistic note, Chewy could encounter challenges in sustaining its growth within the pet health prescription and over-the-counter drug markets. This could occur if veterinarians are hesitant to fulfill prescriptions through Chewy’s platform, instead preferring to generate profits from prescriptions through their own dispensaries.  Unlike human medicine MD’s conflict of interest rules do not apply to DVM’s.

Furthermore, the pet food category exhibits robust brand loyalty, which raises concerns about Chewy’s vulnerability due to its concentration on a few suppliers. Specifically, relying on its top three suppliers for a third of its sales poses a potential risk.  This also limits its flexibility to expand its private label offerings and forces it to operate on thin margins.

When considering expansion into international markets like Canada and further, Chewy may encounter difficulties based on the history of other consumer companies’ failed attempts. Notable failures like Best Buy and eBay in China, Walmart in South Korea, and Target and Nordstorm in Canada underscore the uncertainty of achieving significant success when taking the Chewy brand abroad, where the business model may not resonate. 

In summary, Chewy has high growth potential with an excellent balance sheet and presents a good opportunity at this current price level for investors to get an entry into this fast growing and attractive category.