Wall Street still isn't ready to buy into Chewy's (CHWY -0.12%) rebound story. The e-commerce retailer's stock has underperformed the market in 2023 on worries over slowing growth trends. Fewer shoppers are placing orders with the pet supply specialist as compared to pandemic highs, after all.
On the bright side, Chewy's average order size is growing, partly thanks to price hikes. And an increasing proportion of shoppers are signing up for its subscription-based delivery service. Yet the company's improving financial position is an even better signal of improving returns ahead for the business.
The bad news
Sure, Chewy's customer base shrank in fiscal 2022, which ended in late January. Its active shopper base declined by 1% in the past year after jumping 8% higher in 2021.
That's a concern for shareholders, since it challenges the company's core growth thesis. Chewy is aiming to win market share in a growing pet supply industry that's increasingly moving to online sales channels. The current growth hangover is likely temporary, but investors are understandably concerned to see the company take a small step backwards on customer retention.
The green flag
That pullback didn't happen in a vacuum, though. Chewy raised prices on most products due to rising costs. This move contributed to an improving financial position for the business despite its slowing growth trends.
CHWY Gross Profit Margin data by YCharts
Average annual spending rose to $495 per customer from $450 per customer in 2021, for example. Price increases also pushed gross profit margin higher by 1.3 percentage points to 28% of sales.
That level is near the top end of the guidance range that management had estimated for the business. Executives said in a March letter to shareholders that there's room to boost that figure to new records. "We believe there is additional runway left" for improving profitability, they said.
Dollars and cents
Investors don't have to wait for some future, theoretical improvement in Chewy's finances. Along with the gross margin increase, the retailer in 2022 achieved positive net income and much higher free cash flow.
These wins give it a stronger position to invest in growth through a wide range of selling conditions in late 2023 and beyond. Chewy is preparing to expand internationally, for example, and is pouring resources into its private brands and its push into pet health and insurance.
Cautious investors might want to wait for more concrete signs of accelerating growth before buying the stock. A return to steady customer acquisitions would be key to watch, as this recovery would likely amplify sales gains thanks to Chewy's higher product prices.
But part of the draw for Chewy's stock has been lower risk due to the resilience of its industry niche, which tends to perform well even through recessions. The risk in owning the stock has been reduced by the business' improving financial footing, too.
Toss in a much lower stock price valuation compared to a year ago, and the threat of a sharp decline looks even lower. That's a positive sign for investors who believe in Chewy's long-term growth potential.
