Investors aren't sure what to make of Chewy's (CHWY 0.19%) short-term growth prospects. On the bright side, the pet supply retailer capitalized on its premium market position in 2022, with sales growth and rising prices combining to return the company to profitability.
On the other hand, Chewy lost customers for the full fiscal year. And demand from its remaining shoppers tilted more toward consumable products that carry lower profit margins, leading to concerns about its annual earnings potential.
But who's right about the stock: the bears or the bulls? Let's dive right in.
The bearish thesis
The bearish thesis is straightforward and assumes that the retailer will struggle to post strong sales growth and earnings.
Chewy's expansion rate slowed to 14% last year from 24% in 2021. And while it did generate profits, net income was just $49 million, or less than 1% of sales.
Other retailers are generating stronger profits at about the same level of growth. Walmart, for example, grew its U.S. e-commerce business by 12% in the most recent quarter.
Chewy had a less favorable selling environment, as pet adoption rates slowed compared to pandemic highs. And the company shored up its financial position by raising prices. Yet it's easy to see how the retailer might post a second straight year of weak sales and earnings in 2023.
The bullish outlook
Bulls will point to several factors that imply stronger operating returns ahead.
Yes, Chewy's customer base shrank by 1% in 2022. But these losses were driven by price increases that improved its financial position. The company won market share in the pet supply industry, too. And Chewy generated positive cash flow even at this early stage in its global expansion plan.
These wins position Chewy to lead the industry out of the current cyclical slump, whether that rebound starts in 2023 or later.
The business could be relatively insulated from a recession, too. A full 73% of sales last year came from its subscription-based business, up from 70% a year ago. And more than two-thirds of sales currently come from pet essentials like food.
Demand for these staples isn't likely to fall hard, even if consumer spending contracts.
Is it a buy?
The good news is that investors aren't being asked to pay a high premium for the stock today. Chewy's shares are valued at below 1.5 times annual sales. For context, the P/S ratio was above 2 at several times in the past year and peaked at more than 6 during the pandemic stock market rally.
Chewy seems likely to improve on its profit margins over the next several years. Its growth pace will depend on initiatives like its push into the pet health and insurance niches, along with an imminent entry into international markets.
Sure, it might be several quarters before investors have a good reading on how these shifts are impacting sales and profitability. There are other retailing peers, both inside and outside the e-commerce niche, that are producing solid annual earnings.
However, Chewy's cheap valuation should allow room for patience as investors gain clarity about the business. In the meantime, it's likely to post another year of sales growth in 2023 that expands its annual base further above $10 billion. That gathering scale, plus continued customer loyalty, should support market-beating returns for the business over time.
