As I write this, shares of pet e-commerce company Chewy (CHWY 2.99%) are hitting all-time lows of $17.51 -- maybe they'll be even lower by the time you're reading this. It's about an 85% drop from the stock's all-time high. I think I know the things that have caused the market to completely abandon this former market darling.
But I believe the market is dead wrong to give up on it so soon. If I'm right, Chewy stock is a wonderful buy today. Here's why.
Credit where credit is due
The trends benefiting Chewy aren't new. Pet ownership in the U.S. is strong at 66% of households and spending is expected to increase 5% this year, according to the American Pet Products Association. Pew Research Center found that 97% of pet owners consider pets to be family members, suggesting spending on them isn't considered discretionary. And global e-commerce sales are expected to rise from 19.5% of retail spending in 2023 to 23% in 2027, according to Statista.
In summary, pet owners love their pets, they're spending more for their pets, and consumer spending is still generally shifting from stores to the internet. Factor in the cost benefits of running an e-commerce business compared to a brick-and-mortar operation, and investors can clearly see all the things working in Chewy's favor.
If the pet e-commerce space has so much going for it, then why aren't more start-ups jumping in? Well, there is one (not so) small challenge to overcome: logistics. And it's a hurdle that Chewy already jumped over, giving it a competitive advantage compared to would-be challengers.
With over $10.8 billion in trailing 12-month net sales and 20.4 million active customers, Chewy has scaled its business to the point where profits are possible. The chart below shows that the company's earnings per share (EPS) are now positive, thanks in part to its higher revenue.
CHWY Revenue (Quarterly) data by YCharts
Chewy can deliver pet products to 80% of shoppers overnight using its own logistics network. Building out 17 fulfillment centers is no small task and came at great cost. But with the network largely built out and with centers running at high capacity, Chewy can finally enjoy the benefits of scale and rake in the profits.
Moreover, Chewy is scaling intelligently. Thanks to ongoing investments in automation, fulfillment centers are operating efficiently. Two facilities are already automated, two more are receiving investments, and another will be automated next year.
The problems that investors need to look past
But Chewy is struggling to grow. The company's customers are spending more, on average, which is great. But active customers -- defined as people who've made a purchase within the past year -- have completely plateaued, as the table below shows.
| Quarter | Q3 2022 | Q4 2022 | Q1 2023 | Q2 2023 |
|---|---|---|---|---|
| Active customers | 20.5 million | 20.4 million | 20.4 million | 20.4 million |
Source: Chewy's letters to shareholders. Table by author.
Spending per customer can only be expected to do the heavy lifting for so long before also plateauing. Chewy would benefit immensely from growth in active customers, considering it has the logistics network to support it. But right now, it's stuck in neutral.
Moreover, Chewy's competition is real. As already mentioned, I believe it will be hard for a niche pet e-commerce company to replicate what Chewy has built. But more general retailers like Amazon and Walmart (with its expanding pet business) are formidable. Even Tractor Supply is a huge rival, considering it moves more than 8 billion pounds of animal feed through its supply chain annually.
Finally, Chewy is looking to expand internationally for the first time, starting with Canada. There will be a cost to ramping up business in that country, and I wouldn't be surprised if profitability took a hit during start-up.
With these problems acknowledged, Chewy has growth levers to pull, including the ongoing rollout of pet health services and advertising. Additionally, its user growth might have plateaued for now, but as e-commerce adoption continues, it's hard to imagine Chewy not winning more long-term customers.
And when it comes to international expansion, Chewy showed its operational prowess by turning a profit in the U.S. It's reasonable to assume it can do so again in other markets, even if profits take a temporary step back.
Chewy stock now trades at just 0.7 times its trailing sales, which is the same valuation as Walmart. Walmart's best growth is behind it, so its valuation makes sense. But with the possibility of growth for Chewy, its valuation looks downright reasonable for investors today.
