Online pet retailer Chewy (CHWY 2.99%) started to lose customers in the second quarter. The company's active customer base dropped 0.6% year over year to 20.4 million. While overall revenue rose 14.3% and the company's remaining customers ramped up their spending, this drop in active customers isn't a good sign.
The company pointed out in its letter to shareholders that customers are "being more discerning." In other words, the pandemic-era boom in pet spending seems to be coming to an end as inflation eats away at household purchasing power.
The good news for Chewy is that the weakness was largely attributed to hard goods, which include toys and other non-consumables. Revenue for consumables, by far Chewy's biggest product category, grew by 17% year over year in the second quarter. Chewy's Autoship program allows customers to set up recurring purchases of pet food, which is no doubt a major source of customer loyalty.
Trading down
Pet food spending now appears to be coming under pressure as consumers grapple with inflation, according to a report from The Wall Street Journal. Pet owners have already been cutting back on toys, a fact that showed up in Chewy's second-quarter report. While pet food is a necessity for pet owners, spending is starting to shift to low-cost options.
Premium dry dog food lost 2.9 percentage points of market share in the three-month period ending in July, according to analyst Max Gumport at BNP Paribas. Gumport noted that spending patterns are different in this downturn, compared to previous downturns.
Consumers are pulling back on pet food earlier than usual and before pulling back on other categories. This may be a consequence of the pandemic-era boom in pet ownership, which put a dog or cat in households that previously didn't have pets.
Growth in pet food sales has slowed across the board, with premium sales growing by 8.5% year over year in the second quarter and non-premium sales growing by 14.8%. These compare to growth rates near 20% during much of 2022. While pet owners appear to have initially absorbed rising prices, the party is now over for the pet food industry.
In addition to the shift away from premium dog foods, Chewy noted in its second-quarter report that pet household formation is muted. That makes sense given the boom in pet ownership during the pandemic. There may have been a pull-forward effect, where those who would have otherwise been acquiring their first pet today did so in the past few years, instead.
With customers seeking value, Chewy faces a tough road ahead. Shipping heavy bags of dog food to customers is expensive and may limit how price-competitive the company can be. And with customers shifting to lower-cost pet food, Chewy's margins could come under pressure.
An expensive stock
Chewy is valued at about $9.4 billion. Given the company's profitability, that seems like a stretch. It managed just $18 million of net income in the second quarter, down 15% year over year. Part of the problem: Chewy ramped up advertising and marketing spending by nearly 30% to drive growth.
The company trades for well over 100x earnings if you annualize its most recent results. With sales growth and margins likely to come under pressure as consumers change their behavior in an inflationary environment, and with fewer households acquiring new pets, it's hard to justify paying such a high premium for Chewy stock.
