After riding high during the height of the pandemic, e-commerce pet retailer Chewy (CHWY 2.99%) has had a rough go of it. Down over 65% from its early 2021 highs, the stock has yet to gain any traction in 2022. Hopes of an uptrend were further disrupted after the company's recent fourth-quarter and fiscal 2021 earnings results, which resulted in another drop of 17% the following day.
So has the market sell-off been warranted? There were some weak points in the most recent earnings, but there are also some reasons to be hopeful. As with many investment decisions, prospective shareholders must weigh the good against the bad and determine if the future will be brighter than the past.
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Results may be better than they appear
In Q4 of 2021, Chewy posted revenue of $2.4 billion, a 17% increase year over year. More concerning for shareholders was that this quarter was a deceleration compared to Q3 when revenue increased 24% year over year. However, it is worth noting that 2021 featured tough comps, as each quarter was being compared to 2020 when lockdowns led to increased e-commerce spending.
Autoship sales (where customers have pet products shipped automatically on a set schedule) increased 21% year over year, reaching an annual run-rate of $6.8 billion, almost matching Chewy's total 2020 net sales. Additionally, active customers increased 7.6% over 2020, and net sales per active customer increased 16%. The fact that existing customer spending is outpacing the addition of new customers suggests that Chewy is proving itself to be of value to pet owners.
The gross margin took a year-over-year hit, dropping from 27% to 25%. Management attributed this margin compression to inflation and shipping costs but noted that price increases implemented in Q4 had not yet been reflected in results. However, even with this Q4 margin decline, full-year gross margin still rose 120 basis points over 2020.
Fiscal 2021 ended with a net loss of $74 million, but this is an improvement over 2020 and 2019 when the net loss was $92 million and $252 million, respectively. Free cash flow also improved over the past three years, rising from negative $2 million in 2019 to $9 million in 2021. Although companies are often judged quarter by quarter, looking at these results over the past few years shows a company taking steps in the right direction.
Reasons for hope
Management certainly tried to stay positive in the letter to shareholders that accompanied earnings. The company believes that gross margin pressures likely peaked in Q4 of 2021 and that they were already seeing improvement in February. Management also cited a shipping contract with FedEx that should have a positive impact on gross margins over the course of 2022, even with higher fuel prices.
The full-year 2021 gross margin of 26.7% was a new company high, and the long-term gross margin goal for the company is between 25% and 28%. If the worst of the margin compression is behind Chewy, the next few quarters should yield more positive results.
Like any good company, Chewy has big plans for the next few years. Chewy wants to expand on its position as the leader of fresh and prepared pet foods, citing a $1 billion total addressable market (TAM) that is expected to grow to more than $3 billion. Chewy is gaining market share in the pet healthcare space as well, with Chewy Pharmacy sales increasing 75% in Q4. The company is also getting into the pet insurance space with a soon-to-be-launched suite of pet insurance plans made possible through a partnership with Trupanion.
Lastly, 2023 will see the launch of Chewy Loyalty, a customer membership program, as well as sponsored ads on Chewy.com. Both of these initiatives should drive revenue and help cement Chewy as a one-stop shop for pet owners everywhere.
Bottom line for investors
There's no denying the fact that the pandemic accelerated some of Chewy's financial results, making 2021's year-over-year numbers look weak by comparison. But taking a step back, it's clear that Chewy is making progress toward profitability and cash flow generation, all while continuing to add features and products to add further value for its customers. With shares discounted significantly from their recent highs, now may be a great time to open a position or add to an existing one.
