More pet owners are shopping on Chewy (CHWY -5.35%) today, but that doesn't necessarily translate into a profitable company. In 2022, the market has been making it pretty clear that it hates unprofitable growth stocks. As a result, Chewy's share price has fallen a steep 69% from 52-week highs.
While Chewy has not yet reported a profit from its business, net sales grew 24% year over year to $8.9 billion. This is a fast-growing e-commerce business serving a $120 billion addressable market.
With Chewy's market cap at $12.8 billion, that level of sales growth suggests the stock could be significantly undervalued. Here's why the stock fell, and why it's now priced to deliver a potential double for investors over the next few years.
The stock is priced just right
In 2020, millions of pet owners suddenly found they couldn't visit their local stores to buy bags of pet food for their favorite furry companion. Online pet supplies retailer Chewy came to the rescue, and sales took off.
Chewy's sales growth accelerated from 37% in fiscal 2020 (which mostly lines up with calendar 2019) to 47% in fiscal 2021. Over the last two years, Chewy has added 7.2 million customers, bringing its total customer base to 20.6 million at the end of January.
The problem is investors extrapolated that sales performance too far into the future. At the start of 2021, the stock traded at a high price-to-sales (P/S) ratio above 6. Even Amazon didn't earn a valuation that high. Now Chewy is a more sound investment at a lower P/S ratio of 1.44.
Chewy's business fundamentals are improving
Another reason to like Chewy is that the bottom line is firming up nicely. As Chewy grows larger, Chewy's annual net loss has improved from $267 million to $74 million over the last three years.
Analysts don't expect Chewy to post a profit anytime soon. The consensus analyst estimate has the company posting a loss of $0.45 per share this year and a loss of $0.16 next year. But just getting close to breakeven should be good enough for now. Management's priority is to acquire new customers and grow sales. The business is designed to reduce transaction and operational costs as sales volume increases. We can already see this playing out with the company's net loss improving each year.
More sales growth will push the stock higher
The pet industry is projected to grow about 6% per year, according to Global Market Insights. Another estimate by Grand View Research projects e-commerce spending within the broader pet industry to grow nearly twice the rate at 11% per year through 2027.
Chewy has been growing much faster than these rates, which means it's gaining more brand awareness and becoming a popular online destination for pet owners. It's got a massive selection of 100,000 pet products and is also starting to expand into ancillary services, such as Chewy Pharmacy, where sales increased 75% in the fourth quarter.
With the stock trading at a lower valuation after the sell-off, Chewy should deliver a return that parallels the growth of sales. If Chewy can continue to grow somewhat faster than the e-commerce pet market, such as 15% per year, the stock could double in value by 2027. Given the company's position in this burgeoning market, there's a good chance Chewy will deliver.