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The Fly in Chewy's Second-Quarter Ointment

By Asit Sharma – Updated Sep 19, 2019 at 5:13PM

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Investors have a solid reason to quibble with results despite the pet retailer's rampant growth.

Chewy (CHWY 1.90%) shares traded down 6% Wednesday following release of the online pet products seller's fiscal second-quarter 2019 earnings on Tuesday evening. Management showcased some items, including year-over-year revenue growth of 43% and a sizable jump in gross profitability. Yet shareholders obviously weren't won over. Below, we'll review highlights from the quarter and zero in on one of the most salient reasons shares fell. Note that all comparison numbers that follow refer to the prior-year quarter.

Chewy: The raw numbers

Metric Q2 2019 Q2 2018 Change
Revenue $1.15 billion $805.6 million 42.8%
Net income (loss) ($82.9 million) ($63.1 million) (31.4%)
Diluted EPS (loss) ($0.21) ($0.16) (31.2%)

Data source: Chewy. EPS = earnings per share. 

What happened this quarter?

  • Chewy's top line slightly exceeded management's guidance for second-quarter revenue of between $1.12 billion and $1.14 billion.
  • Gross margin jumped by 300 basis points to 23.6%, which the company attributed to healthier product margins and supply chain efficiencies.
  • Chewy's base of active customers expanded by 39% to over 12 million, while net sales per active customer (over the last twelve months) grew 10% to $352.
  • Within its newest business, Chewy Pharmacy, the company launched online tools to help pet owners better manage their pets' medications and prescription diets.
  • Sales through the organization's "Autoship" subscription program increased by nearly 49% to $800 million, while Autoship sales as a percentage of total sales increased by 250 basis points to 69.3%. (While these are impressive statistics, investors may want to read my colleague Tim Green's recent explanation of why Chewy's Autoship figures should be taken with a grain of salt.)
  • Despite higher sales and much-improved gross profitability, Chewy's year-over-year quarterly loss only widened as operating expenses swelled. Selling, general, and administrative expense (SG&A) soared 75% to $355 million, while advertising and marketing expense rose 24% to $111 million. Total operating expense jumped 55% to $335 million. The higher overhead proved a fly in the ointment this quarter, revealing a lack of operating leverage in the context of torrid sales growth. The company's operating loss increased by 32% to $82.9 million.
A house cat appears to be impatient as it perches on a kitchen table and waits for food in its bowl.

Image source: Getty Images.

What management had to say

Chewy issues a letter to shareholders with each earnings report. In the current missive, management discussed investments in fulfillment and logistics that are vital to scaling the company's sales and also necessary for building margins with an eye toward eventual profitability. In the following excerpt, management discussed a typical capital investment that will extend Chewy's delivery prowess:

We recently broke ground on our ninth fulfillment location in Salisbury, North Carolina. This new facility will be one of the largest in our network and is expected to enhance delivery capabilities across the Mid-Atlantic region. We also implemented an industrial-grade enterprise transport management system to drive continuous improvement in transportation and overall supply chain management. With the robust functionality this system will deliver, we will be able to better plan inbound and cross-fulfillment center transportation operations.

Looking forward

Chewy raised its full-year fiscal 2020 guidance alongside earnings, but very slightly. The company expects 2020 revenue to fall between $4.75 billion and $4.80 billion, versus its previous forecast for $4.675 billion to $4.75 billion. The only other guidance item Chewy publishes is its expected improvement in adjusted EBITDA margin. The company anticipates adjusted EBITDA margin growth of 420 to 450 basis points this year, which tightens up its prior expectation of 400 to 450 basis points.

For the fiscal third quarter, Chewy advised investors to expect revenue of $1.19 billion to $1.21 billion, representing an advance in the top line of between 36% and 38%. While that's an appreciable pop, it nonetheless follows a sequential trend of decelerating year-over-year growth: Revenue expanded by 45% annually in the first quarter, followed by 43% growth this quarter. The slower expansion rate is perhaps another factor behind shareholders' disappointment yesterday. Shares of this recent initial public offering, which debuted in June, are now down 19% from the closing price of $35 notched on the company's first day of trading.

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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