Pet-focused e-commerce company Chewy (CHWY -0.64%) is a great example of a smaller player finding success in a large industry like e-commerce by focusing on a specific niche. Homing in on a particular target audience and serving it well can help establish brand power against the big players like Amazon that do a little of everything.
Chewy's stock has fallen more than 50% over the past year and now sits within shouting distance of where it traded when it went public in 2019. I'll show you why Chewy's pullback is an opportunity to buy stock in a business that's getting stronger and why the stock could produce strong total returns for investors.
The pet industry is big business
Chewy is an e-commerce business that sells various pet products like foods, treats, toys, and medications online. You can buy them, and they'll be shipped from Chewy's fulfillment centers across the United States to your door.
Pets play a crucial role in many people's lives; they're a companion for some and protectors for others. If you own a pet, you probably consider it a part of the family. Our little friends need care, and pet owners spend a lot of money on that care. The American Pet Products Association estimates that pet spending will hit $109 billion in 2021, up from $90 billion in 2018.
Image source: Getty Images.
Being specialized as a pet retailer, Chewy has some potential advantages over a broader competitor like Amazon. For example, Chewy's supply chain is focused solely on pet products, which helps it sell at lower prices: 11% lower than the typical retailer on average, according to a study done by NBC.
It also offers complementary services within the e-commerce platform, like Chewy's pharmacy for pet medicines and veterinary telehealth services. The company is trying to be an all-in-one care solution for pets, accessible from your smartphone or computer.
Chewy's financials are improving as the business grows
Chewy's revenue has grown significantly since going public; lockdowns during COVID-19 have probably helped encourage people to shop online, and the idea of having pet supplies delivered to your door seems like an attractive value to consumers. Revenue was $4.85 billion in 2019, and grew 47% year over year to $7.15 billion in 2020. Analysts expect full 2021 revenue of $8.9 billion, growing 25% over 2020.
But what I think is essential is how the company's financials have improved as revenue grows. The gross profit margin has expanded from 24.1% at the end of 2020 to 26.4% in the company's most recent quarter, the third of 2021. It's especially impressive in the current high-inflation environment, where many companies have cited rising supply chain and shipping costs.
CHWY revenue (TTM). Data by YCharts. TTM = trailing 12 months.
The company also began producing meaningful free cash flow in 2021, which signifies that Chewy's revenue growth is outpacing its costs. For investors, this means that the business shows a potential path to profitability. While the company posted a net loss of $32 million in the third quarter of 2021, investors could reasonably expect net income to turn positive over the coming quarters.
The stock's pullback creates a buying opportunity
The stock market got a little hot in early 2021, and Chewy saw its valuation multiply; the price-to-sales (P/S) ratio climbed to more than 6 and has since fallen to under 3, near its lowest since the company went public. Shares fell from $120 per share to the low $50s.
CHWY P/S ratio. Data by YCharts.
Amazon trades at a P/S ratio of 3.4, so Chewy's valuation seems relatively on par with its competitors. Amazon is a more proven company, so a premium is probably fair.
It's debatable whether Chewy's stock is a bargain today. Still, at the very least, it seems that the valuation could allow for revenue growth to be reflected in the stock's total returns. For a company growing revenue at more than 20%, that's all you need to have a significant investment outcome.
It might not be an explosive growth stock, but if it can hold long-term revenue increases above 10%, there's a lot to like in a business that seems to be hitting its stride financially. Chewy still serves less than 10% of the U.S. pet market, so there could be a bit of room left for this stock to run.
