Investors have put Chewy (CHWY 2.99%) back in the doghouse. The pet supply specialist's stock, which had been beating the market in early 2023, is down 16% through early August compared to a 17% increase in the S&P 500.
There are some potentially good reasons for Wall Street to feel cautious about this e-commerce retailer. Yellow flags include modest sales growth and a shrinking customer base over the last few quarters. Yet investors shouldn't focus too much on those short-term issues. Look closer, and you'll see better reasons to like this stock right now.
Let's dive right in to three of them.
1. Customer engagement trends are solid
The major knock on Chewy's stock lately has been a persistent growth hangover from the pandemic. The company shed 1% of its active shopper base in 2022 and continued to lose customers at that same modest rate in early 2023.
Still, its broader engagement trends are solid. Chewy raised prices on many items over the past year, helping lift its gross profit margin. Shoppers are spending more, too. Average sales per customer rose to $512 in the first quarter, up from $446 million a year earlier.
These pet owners increasingly are choosing to commit to Chewy's subscription-like offering, with 75% of sales coming through its auto-ship service. All told, revenue growth in the first quarter accelerated to 15% even as gross profit margin expanded.
2. Cash flow improvements are encouraging
Chewy's net income isn't impressive today, although the company is consistently generating positive profits. Earnings in the first quarter were $22 million, or less than 1% of sales.
The cash flow picture tells a more encouraging story. Operating cash flow improved to $148 million this past quarter, up 80% from last year. Free cash flow was a solid $127 million.
CHWY cash from operations (TTM) data by YCharts. TTM = trailing 12 months.
This success points to rising net earnings over time, but for now, it means Chewy can invest freely in growth initiatives like its push into pet wellness and insurance. Its upcoming entry into the Canadian market, meanwhile, isn't expected to pressure earnings or cash flow even as it bolsters the company's sales growth possibilities.
3. The stock price is discounted
It's hard to square these positive factors with Chewy's sinking stock price. You can buy shares of the e-commerce retailer for 1.3 times annual sales today, down from a ratio of over 6 at the peak of the pandemic growth days. Chewy's price-to-sales ratio has been sitting over 2 at several points in 2023, as well.
Cautious investors might be happy to pass on that discount while they watch for signs that Chewy can return to steady growth in its customer base. These might arrive as soon as late 2023.
But better returns will be available if you're willing to take on a bit more risk and uncertainty. Sure, there will be volatility with this stock over the next few quarters. And Wall Street seems skeptical that the e-commerce business can sustainably generate strong annual profits.
Most growth and financial metrics are pointing in that direction, though, and so it might just be a matter of time before the stock's momentum catches up to the business' positive trajectory.
