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Why You Should Be Gobbling Up Chewy Shares

By Evan Niu, CFA - Dec 10, 2020 at 9:00AM

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The pet products seller had a booming third quarter and continues to add customers at a rapid pace.

Online pet supply specialist Chewy ( CHWY -5.01% ) report third-quarter earnings earlier this week, and the results easily topped expectations on numerous fronts. Investors weren't quite sure how to parse the figures, with shares briefly touching record highs in volatile trading on Wednesday. Demand for pet products, particularly on e-commerce platforms, has soared during the COVID-19 pandemic.

Despite the volatility, here's why long-term investors should be gobbling up Chewy shares.

A dog and cat eating pet food from a pet food bowl with two separate wells

Image source: Getty Images.

Firing on all cylinders

Revenue in the fiscal third quarter jumped by 45% to reach $1.78 billion, which topped both Chewy's guidance ($1.7 billion to $1.72 billion) and the consensus estimate ($1.73 billion). That translated into a net loss per share of $0.08, which was better than the $0.13 per share that analysts were expecting the company to lose.

Chewy added 1.2 million active customers during the quarter, and net sales per active customer ticked up on a sequential basis to $363. The company continues to steadily add customers while getting those buyers to open up their wallets even more. The core Autoship program generated over $1.2 billion in sales, representing 69% of total revenue. That proportion is staying very consistent, providing Chewy with recurring revenue and meaningful visibility into the sales pipeline.

Gross margin was flat on a sequential basis, which CEO Sumit Singh attributed to less aggressive promotional activity than expected. However, promotions did start to ramp up near the end of the quarter as the holiday shopping season came into view. Many other operating metrics improved heading into the final stretch of 2020.

"Volume in the back half of the quarter outperformed expectations as traffic, conversion, orders, and customer retention all strengthened from September into October as customers shifted their shopping behavior this year to shopping earlier, responding favorably to our expanded assortment and innovative product and service launches such as personalization and gifting," the company said in its letter to shareholders.

Chewy is making progress on several other strategic initiatives. The pharmacy business is growing well and is expected to bring in $500 million of gross revenue this year, which the company believes makes it the largest e-commerce pet pharmacy in the U.S. On a net basis, pharmacy sales are expected to be $350 million, which should represent around 5% of total sales for the year. The pharmacy segment has now achieved enough scale to start contributing to gross profits.

Operating cash flow skyrocketed to $63.4 million, up from just $1.6 million a year ago. That money is allowing Chewy to invest aggressively in the business, particularly its fulfillment network. After spending $30.5 million in capital expenditures, Chewy generated $32.9 million in free cash flow.

Looking ahead

Guidance for the fiscal fourth quarter was also strong, with revenue forecast in the range of $1.94 billion to $1.96 billion. That outlook is ahead of the consensus estimate of $1.79 billion. That should bring full-year revenue to $7.04 billion to $7.06 billion, representing 45% growth from 2019 at the midpoint.

It was a strong quarter that reinforced Chewy's growth trajectory. The company's business has benefited from shifting purchasing patterns caused by the pandemic. Even after vaccines become available and the crisis subsides in the months ahead, Chewy expects to keep posting impressive results thanks to the sticky nature of Autoship -- overall customer retention has increased by 6 full percentage points year to date. Singh believes that data point helps "address the question that we've all been wondering about through the onset of this year as to are we going to be able to retain the cohort of customers that we are acquiring during the pandemic."

Ignore the volatility from yesterday. Chewy is set to be a consumer staples winner in the years ahead, as "the demand that we're seeing is primarily organic and structural in nature," according to Singh.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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