Chewy (CHWY 2.99%) was a breakout stock during the pandemic as everyone rushed to bring home a furry companion. But more recently, the online pet-products retailer has been left in the doghouse.
Chewy stock is down 69% since its peak in early 2021, but that hasn't humbled Wall Street. Most analysts still rank the stock as a buy, and one of them believes it could jump 51% in the next year.
That's RBC Capital's Steven Shemesh, who has had a $56 price target on Chewy for nearly a year now, reiterating the rating several times.
Shemesh has given the company credit for its improving margins and sees continued growth in its number of customers and net sales. However, Chewy has struggled to break out of the range it's been trading in for the last year, even as profitability has significantly improved.
Can Chewy gain 51% over the next year or is that forecast too optimistic? Let's look at a few challenges the company has to overcome in order to get there.
Image source: Getty Images.
Growth is slowing
Chewy is priced like a growth stock, but there's a problem with that. Its revenue growth continues to decelerate, which appears to be a function of a maturing market, competition from peers like Petco, and a shift in consumer spending to services like travel and restaurants after a boom in spending on at-home products (like those for pets) during the pandemic.
The pet products industry has historically been recession-proof, which is good news for investors. But it's also not a high-growth industry, and the pandemic likely had a pull-forward effect on demand. If you were considering getting a pet when the pandemic started, that likely pushed you to do it. Similarly, e-commerce sales also spiked during the pandemic and have since cooled off.
Because the industry is only growing modestly, Chewy's growth needs to come from taking market share from brick-and-mortar stores and other online competitors like Amazon. It's a fragmented industry, which makes it easier for Chewy to gain share. But you can see from the chart below that revenue growth has slowed to between 12% and 15% over the last several quarters after its earlier boom.
Data by YCharts.
The hangover from the pandemic is best evidenced by a decline in active customers, which fell 0.9% in the first quarter to 20.4 million. While that number has been flat in recent quarters, the company has made up for it by growing net sales per customer, which increased 15% to $512 in the recent quarter.
That metric has risen thanks to growth in its Autoship subscription program and increased cross-category purchases, which could mean a customer buying a chew toy or a tick-prevention product when they're also buying food.
Over the long term, however, growing the customer base is a more sustainable way to grow the business as there's a limit to how much customers will spend, especially since something like food intake is limited.
Chewy also said it was expanding into Canada, its first international market, which will increase its addressable market by 12% to 15%. It's planning to launch in Canada in the third quarter.
Looking ahead, the company expects full-year revenue growth to slow to just 10% to 12% (down from 13.6% last year), a sign that its high-growth days are likely behind it.
The profit question
In general, stocks either need to show growth or profits to command Wall Street's attention. Chewy's profitability is improving but still lags behind peers like Petco.
In the first quarter, Chewy's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin improved from 2.5% in the year-ago quarter to 4% to reach $110.2 million. Its generally accepted accounting principles (GAAP) net margin held steady at 0.8%, while its free cash flow jumped from just $6.4 million to $126.8 million, due in part to a decline in capital expenditures from $76 million to $22 million.
In its guidance, the company called for a 3% adjusted EBITDA margin for the year.
Chewy's guidance may be conservative, but it's going to become harder for the company to improve margins as revenue growth slows. It's also worth noting that Petco's GAAP net margin is slim as well at just 1.5% for its latest fiscal year. That's a bad sign for Chewy as it shows that wider margins might be hard to achieve and that the industry is still highly competitive, despite Chewy's leading position in the e-commerce market.
In order to gain 51% over the next year, Chewy will need a catalyst, but it seems unlikely that one will emerge at a time when growth is slowing, a recession is threatening the economy, and industry dynamics have made profitability difficult to achieve.
