Chewy Is More Than Just E-Commerce

Chewy (CHWY 1.92%) is best known as an online pet supplies retailer, but the company is expanding beyond e-commerce. It's now offering insurance products and other services, and has a marketplace for veterinarians.

In this episode of "Upgrade or Topgrade" recorded Oct. 15, Fool contributor Parkev Tatevosian and Millionacres Editor Deidre Woollard explain how Chewy is moving beyond the confines of e-commerce to becoming comprehensive pet services company.

Deidre Woollard: I think with Chewy, this has been one that has really benefited from the pandemic. Now I think it's in a place where the market isn't as in love with it as they were maybe a year ago.

Parkev Tatevosian: Yeah. Certainly was one of the market darlings during the pandemic. Since January, I think the stock has fallen from the high of $120 per share to I think it was trading at around $64 a share today. The market is certainly worried about how it's going to adjust as world economies come out of the pandemic. Chewy has been punished because of that.

Woollard: Yeah, I think that's true. Let's talk about what Chewy does. At its core, its core business was just in the beginning, I think delivering pet supplies and subscription, like getting people into that group of being at Chewy customer. Now it seems like they're really branching into a couple of different areas as they grow, right?

Tatevosian: Right. They initially started just offering mostly third-party products on their website and now they are expanding into, they're making their own proprietary products. Those come with higher margins for Chewy so that's helping the gross profit margins expand. Recently they're entering into a few pet help areas. To specifically telehealth services. What that is, customers of Chewy's auto-ship program, which is something similar to Amazon Subscribe and Save program. Customers who sign up for that get access to the free telehealth services where they can call a veterinarian over the phone or online and speak to a veterinarian about their pet. Then the second area they're expanding into is compound medicine. Certain pets, think about if you have a pet who won't swallow a pill maybe, but will take all the medication if you put it in water. Compounding the medicine, putting in the various forms that your pet will be able to eat it in or consume it in.

Woollard: I was fascinated by the compounding pharmacy thing because I was listening to their earnings and the compounding sales increased almost 50 percent sequentially between the first and second quarter on increased order volume and larger basket sizes. They said that another thing about this is that, it's an area where there isn't as much competition. It's actually attracting new customers to Chewy Health. That's 65 percent of the new compounding customers were either new to Chewy entirely or existing Chewy customers who may be became first-time Chewy Health customers.

Tatevosian: Yeah, that's a great point Deidre. An interesting thing about that or a good thing about that for Chewy is that, if your pet is on medication, then that's probably something that they're going to need either every two weeks, or every month, or certain regularly recurring area. That's a way that Chewy can bring in those customers and sign them up to the auto-ship program. Then a customer might say, "Well, I'm already ordering this medicine from Chewy, let me go ahead and add a certain dog food to it." Now they've added a second product which can increase profit margins because now they're putting two products into that package and delivering it to you rather than just delivering one product.

Woollard: But let's talk about their shipping a little bit because I think that's fascinating. Any company that's in the e-commerce business has to really start thinking about shipping. They've got 14 fulfillment centers, they're adding an automated fulfillment center in Nashville next year, but one of the things I thought that was cool that they're doing is they're adding this technology to make custom boxes based on the size of the content, which is important. Talking about industrial real estate, we've talked about the price of cardboard skyrocketing last year, because extra cardboard adds extra weight, figuring out how to do all of that is really important. Not something you necessarily think about with a pet brand, but something that actually might really help their bottom line and reduce some of the cost and really be important for them as they scale.

Tatevosian: Absolutely. Yeah, you mentioned some of the efficiencies with cardboard, but beyond that, they're adding even more efficiencies to their fulfillment centers. Changing of the boxes and then the operating leverage, reducing future exposure to labor market volatility by adding those efficiencies now the personnel in the fulfillment centers can fill those boxes more efficiently and the need for labor is reduced. All in all, they said that those efficiencies in the fulfillment center should combine to add about 70-110 basis points of incremental adjusted EBITDA margin. Pretty significant improvements.