Chewy (CHWY -2.48%) shares have taken a beating over the last year. The stock is currently down 74% from its all-time high in early 2021. A combination of slowing sales growth and a high valuation contributed to the slide.
Perhaps the biggest problem for investors is that Chewy reported a loss of $74 million in fiscal 2021 (which ended in January). However, it's not a question of if, but when, Chewy turns a corner on profitability.
One opportunity that could lift both the top and bottom line at Chewy is the launch of sponsored ads, which management plans to introduce in 2023.
A high-margin revenue opportunity
Chewy has a great advantage in the online pet market with over 20 million active customers. Suppliers see tremendous value to gain exposure for their brands across a large and growing customer base. Chewy's active customers not only grew 7.6% year over year in fiscal 2021, but net sales per customer increased even more at 15.6% year over year. These numbers reflect a loyal base of customers who love buying pet food for Fluffy on chewy.com.
During the fourth-quarter earnings call, CEO Sumit Singh explained that Chewy has been building bespoke advertisements for years, so it already has experience in this area. Launching contextual advertisements on chewy.com could drive higher spending per customer, since Chewy can serve contextual ads showing relevant products that shoppers are already searching for.
It's for these reasons that Singh described the launch of sponsored advertisements as a "high-margin revenue" opportunity.
Image source: Getty Images.
Why the stock is a fantastic buy right now
Amazon (AMZN -3.19%) has seen its profit margin explode in the last five years as growth in non-retail businesses, including cloud services and advertising, has taken off. In the fourth quarter, Amazon's advertising revenue grew 33% year over year and is now a $31 billion annual business for the e-commerce giant.
Chewy is already seeing its profit margin improve significantly. It's just barely under breakeven with a trailing-12-month profit margin of negative 0.83%. Clearly, advertising revenue would be enough to tip the bottom line above breakeven.
CHWY Profit Margin data by YCharts
Chewy shares now trade at a low price-to-sales ratio of 1.41. If Chewy can eventually achieve the same profit margin as Amazon of around 7%, there could be considerable upside for investors. Amazon currently trades at a P/S ratio of 3.1, or more than double Chewy's valuation.
Over 3,000 brands sell more than 100,000 products on chewy.com. The wide selection should provide Chewy with a variety of ads to target customers shopping in different categories. This spells a large revenue opportunity that could significantly pad Chewy's $8.9 billion of annual revenue.
With this lucrative opportunity, the stock is a great buy. The market for pet spending is massive compared to Chewy's annual revenue, and the company has a clear strategy to expand margins.
