Sometimes stocks decline for all the wrong reasons. Wall Street can stay too focused on short-term concerns around a business or an industry, for example, while ignoring a company's bright future. Industry downturns are a regular part of the economic cycle, after all, and don't seriously threaten the long-term outlook for a company.
But shopping for deep discounts can also be risky because falling stocks aren't always due to bounce right back. So, which of these two situations better describes Foot Locker (FL 0.23%) and Chewy (CHWY 2.99%) shares, which have each declined sharply in 2023? Let's dive right in.
Foot Locker has issues
Foot Locker has reduced its fiscal-year outlook twice so far in 2023, giving investors plenty of reasons to consider selling the retailing stock, which is down about 50% year to date. Comparable-store sales fell by a painful 9% in the most recent quarter, and management warned about further weakness ahead as price-cutting continues to be necessary to attract shoppers into its stores.
Investors shouldn't expect a quick recovery here as Foot Locker's falling profitability illustrates how little pricing power it holds in the industry. In contrast to Nike (NKE 0.19%), which is predicting rebounding gross margins, Foot Locker in late August said it is expecting to be hurt by more-aggressive markdowns at least through the rest of 2023. The company paused its dividend payout, too, suggesting major challenges around cash flow.
Foot Locker is being further squeezed by Nike's decision to sell more footwear directly to consumers. That trend makes sense for other manufacturers, too, which can all boost profit margins by cutting out third-party retailers and building relationships directly with shoppers. Given these competitive and financial issues, investors are better off watching this falling stock from the sidelines.
Chewy will bark again
Chewy's 34% stock price decline this year, on the other hand, seems untethered from its operating momentum. The pet supply specialist posted 14% higher sales in the most recent quarter and beat management's short-term outlook. Gross profit margin rose slightly, and Chewy remained profitable in the selling period that ran through late July. Cash flow is improving and is in solidly positive territory.
Sure, there are challenges mounting for the business. Chewy's base of customers has been declining for over a year, for example. And management recently said shoppers have become more cautious in their spending, potentially jeopardizing the rebound that investors were hoping to see in the second half of 2023. The company's net profit margin is sitting below 1%, which isn't impressive.
Yet Chewy's customers remain highly engaged with the business. The proportion of shoppers using its subscription-based service rose last quarter to a record 76%. Average annual spending jumped 15% to $530 as well.
Executives are optimistic about their many growth opportunities ahead, including the current push into the Canadian market and the pet health and insurance niches. "We are just getting started and believe we still have considerable runway," management said in a recent shareholder letter, "with clear potential to outperform the broader pet industry and drive both strong growth as well as significant margin expansion."
Wall Street is in a wait-and-see mode as it watches for clearer signs of this growth acceleration. The rebound might not be obvious until 2024, given the pressures on consumer spending right now. But Chewy has a bright future that isn't reflected in the stock's slump this year. Spending on pet supplies will recover from this current slowdown, and the online retailer should be able to continue boosting its market share -- and annual earnings potential -- over time. While Foot Locker's recovery is questionable, Chewy will be back.
