Why the Market Had a Bone to Pick With Chewy's Earnings Report

Chewy (CHWY 2.23%) delivered its first earnings report as a public company Wednesday, and given that it featured a smaller-than-expected adjusted loss along with a guidance boost, one might have expected the market to applaud. But no -- shares of the online retailer of pet products lost ground.

In this segment from MarketFoolery, host Chris Hill and senior analyst Emily Flippen discuss the reasons why the investing public might have been disappointed, and reflect on Chewy's sales and marketing expenses, its place in the market, its long-term strategy, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 18, 2019.

Chris Hill: Let's move on to Chewy, which is the pet food and products retailer. Chewy's second quarter loss was smaller than expected. They raised revenue guidance for the full fiscal year. Chewy's stock, down about 5%? Why is it down? I don't own the stock, but I just look at this and think this is what you would want to see if you're a shareholder.

Emily Flippen: I'm not a shareholder yet, but I'm a big fan of this business. I was happy by their recent report. I feel like some of the market -- I don't want to call it "confusion" -- market response is twofold. First, this is their first report since becoming a publicly traded company. We've seen the market destroy a lot of these high-flying IPOs. It's not a terrible surprise, since they didn't completely blow out expectations, that the market responded the way it did. But, also, they posted a narrower than expected loss as long as you take out the non-stock-based compensation expenses. If you include that, it's actually a significantly bigger loss. I guess it depends on how people are perceiving the losses attributable to them as shareholders. Are they including stock-based compensation, are they not? Personally, when I look at these types of companies, which are still very much in the growth stage, I don't tend to add a lot of sway to stock-based compensation. But I can understand why investors do. Ultimately, Chewy is not profitable, so it makes sense that people, when they see that sticker shock of the first number, they think, "Is this company ever going to be profitable?"

I'll give my quick, two-second Chewy pitch here. Chewy could easily be profitable if they just scaled back their marketing expenses. Chewy continuously shows that the lifetime value of the customers that they acquire significantly outpace the amount that they spend to acquire that customer in sales and marketing. The fact is, the company doesn't want to be profitable right now. In fact, if you're thinking about FedEx, thinking about some sort of pullback in the market, pet supplies tend to be pretty resilient when it comes to recessions. And Chewy by far has the biggest presence for online pet sales, and it's still really nominal, the number of purchases that are made online for pet sales in comparison to apparel or electronics. So there's significant room there for new customers to come into Chewy's atmosphere, for Chewy to acquire those customers. This year, they're projected to do about $5 billion in sales. It's a big, big business. It's not pets.com, as many old school investors might think. But it's an exciting company. They have active customer growth of 49% year over year. Gross profit margin improvement. Lots to like here. Personally, I see this pullback and I get a little bit excited. If I could just keep my mouth shut about the company, maybe I could actually buy some.

Hill: Is this a company that you think is potentially an acquisition target? I'm thinking of a couple of years back, when Blue Buffalo, which is in this line of business, was a public company, stand-alone. And General Mills came in and snapped it up for around $8 billion. Chewy, right now, valued around $11.5 billion. It'd be a little bit more that someone would have to pay for them. But if you're making up a list of reasons to buy this stock, is that on the list?

Flippen: No, not at all. 100% never going to be acquired. That's because the company was actually sold to PetSmart by its founder back in 2017. PetSmart now owns the vast majority of the business, virtually the entirety of the voting control of the business. And that's the single biggest risk with this investment. I was probably remiss for not mentioning it in my quick pitch earlier. Ultimately, PetSmart is a declining business. They're are an old school retailer and they're going to leverage their ownership of Chewy's to the best extent that makes PetSmart money, not investors. I don't think this is a company that PetSmart is going to ever consider selling to somebody looking to acquire it, simply because it's the only part of their business that is offering any growth opportunities.