Chewy (CHWY 4.00%) has become a go-to online destination for pet owners to shop for food and other supplies. The company's increasing scale has even allowed it to expand into pet healthcare. It's an attractive industry to invest in with the pet market historically growing around 5% per year and estimated to be worth $98 billion in 2020.
After more than tripling last year, Chewy's share price is down 12% year to date as of this writing. The company just reported fiscal second-quarter results that showed a wider loss on the bottom line than analysts expected.
Though shares shed 9% the day after the earnings announcement, it may not be the bottom-line miss that's causing the stock's decline. Let's review how Chewy's business has performed recently, its growth opportunities, and whether the stock is worth buying at its current valuation level.
Chewy is a solid business
Similar to other retail markets, the pet industry is seeing more spending shift from brick-and-mortar to digital. This accelerated during the pandemic with Chewy's revenue growing 47% to $7.15 billion in 2020. Chewy offers a massive selection of products across roughly 2,500 brands. It believes its customer-centric experience and attractive prices set it apart in a highly competitive market, and Chewy ended the second quarter with 20.1 million active customers, up 21% year over year.
Through the first half of fiscal 2021, revenue has increased 29% from the same period last year. This slowing growth was expected, given the challenging comparison with the stellar results in fiscal 2020. Management expects revenue to grow between 25% to 26% for the full year, despite dealing with supply and labor shortages in the near term.
While Chewy has regularly reported losses on the bottom line, it is largely due to spending on marketing and investments to expand its fulfillment network, which is the right thing to do to get ahead of the competition. Stronger delivery capabilities and a wider inventory selection should lead to more satisfied customers. Despite opening two new fulfillment centers recently, Chewy reported positive free cash flow of $60 million in the latest quarter, a major improvement over the year-ago quarter's negative free cash flow of $56 million.
Pet food on speed dial
Chewy's investments are leading to faster delivery speeds and more competitive prices. Its fulfillment network can ship items to over 80% of the U.S. population overnight. This explains why more customers are signing up for Autoship, which continues to grow faster than one-time orders.
In the first half of 2021, Autoship customer sales grew 32%, and they made up 69% of Chewy's business, which provides a recurring stream of revenue and makes it easier for management to anticipate future sales.
What's more, customers tend to spend more after their first year with Chewy as they discover other products and services, and some of these are part of a calculated strategy to increase the long-term profitability of the company.
For example, in 2016, Chewy launched its first in-house hardgoods brand, Frisco. In 2018, it launched Chewy Pharmacy. These offerings generate higher margins than the rest of the company, and management sees plenty of room to not only grow these areas with new customers over the long term but to also expand into new categories too.
Great company, but the stock is expensive
Chewy has a lot of qualities to like, especially the large and growing market that is still more than 10 times the size of the company's trailing 12-month revenue. But even though the company has a long runway of growth ahead of it, I don't think now is the best time to buy the stock.
It boils down to valuation. The stock currently trades at a price-to-sales ratio of 4.3, higher than Amazon's 4.0 and more than double Wayfair's 2.0 sales multiple.
Analysts currently expect Chewy to grow revenue by 30% this year and about 18% in fiscal 2022. That's not much better than its peers, despite its valuation premium.
Sound investing is about shopping around to find the best bang for your buck, but there are better options in e-commerce right now. I would keep Chewy on a watchlist and wait until the stock represents a better value.