Online pet products retailer Chewy (CHWY 2.99%) is successfully competing with retail giants like Amazon and Walmart. Revenue reached $2.78 billion in the second quarter, up 14.3% year over year as customers ramped up their spending. The company is profitable as well, although just barely. Net income slumped a bit to $19 million in Q2.
Despite Chewy's growing sales, the stock has been hammered over the past few years. This year alone, Chewy stock is down about 35% following its post-earnings rout. Since peaking during the pandemic, the stock has tumbled by nearly 80%.
This steep decline doesn't make Chewy stock a bargain. Given the headwinds the company is facing, Chewy stock still looks too expensive.
Warning signs
While the headline numbers looked fine, there were some warning signs in Chewy's Q2 report. Chewy's active customer base declined by 0.6% year over year to 20.4 million, a potential sign that competition and a tough economic environment are causing problems. Another issue could be the normalization of pet-ownership trends. While pet ownership boomed during the early pandemic, it's now back to being a strong function of home ownership, availability of remote work, household income, and the state of the economy.
Chewy noted in its letter to shareholders that consumers are "being more discerning" coming out of the summer months. While the company's average revenue per customer has risen by 60% since the company went public in 2019, that growth has been partly due to its efforts to grow its pet pharmacy and health businesses.
Consumables revenue rose 17% year over year in Q2, but sales of hardgoods rose by just 2.2%. Customers may be pulling back on some types of purchases as inflation puts pressure on household budgets.
A more discerning consumer will lead to a slowdown for Chewy in Q3. The company expects revenue to grow by just 8% to 9% year over year, while full-year revenue should grow by between 10% and 12%.
While Chewy is profitable, it's not spending all that much on advertising and marketing. Advertising and marketing accounted for just 6.7% of revenue in Q2. The company's autoship program where customers sign up for periodic shipments of products likely helps keep these costs down.
But Chewy is now losing customers, which could mean that higher spending will be necessary to keep the business growing. Chewy did ramp up advertising and marketing spending by 29% in Q2, which was one reason why the bottom line declined. Going forward, profits may remain under pressure as the company spends more to retain its customer base and return to customer growth.
A pricey stock
Chewy is a low-margin retailer, and low-margin retailers generally trade at a fraction of annual sales. While Chewy's valuation has come down, the stock is still valued at what looks like an optimistic level given its sluggish growth and minimal profitability.
Chewy is worth about $10.25 billion following its post-earnings decline. That puts Chewy's forward price-to-sales ratio at about 0.9. That represents a premium compared to Walmart and Target.
CHWY PS Ratio (Forward) data by YCharts.
Spending on pets is unlikely to rise very quickly, even with the pandemic tailwind. Morgan Stanley predicts 8% annual growth for the U.S. pet industry through 2030. The pet population grew during the pandemic as people added dogs and cats to their households, but there's no guarantee this represents a permanent shift in pet ownership. Even if it does, it will be tough for Chewy to grow much faster than it's growing right now.
At the right price, Chewy would make a reasonable investment. But the stock looks too expensive to me.
