Every so often, market expectations for a company will get way ahead of results the company can produce at a sustainable pace. And when sales growth inevitably slows down, investors are quick to sour on the stock. But that can leave those willing to take a long-term mindset with an opportunity to buy a great company going through short-term challenges.

That might be the case with Chewy (CHWY 2.99%). The company saw soaring sales amid the start of the pandemic when it benefited from the combination of soaring pet adoptions and a push toward online retail. But sales growth has come down considerably since then. Management expects sales growth of just 3% year over year for its fiscal 2023 fourth quarter.

But the long-term outlook for Chewy remains strong thanks to its Autoship business, expansion into higher margin products and services, and the growing penetration of e-commerce in the industry. That's why Morningstar analyst Sean Dunlop thinks the stock is worth $36 today, more than double the current share price as of this writing.

Here's why Chewy stock can soar more than 100%.

A strong moat in a growing industry

Dunlop believes Chewy has created a meaningful moat around its business despite operating in a highly competitive industry. The Chewy brand is a household name for pet owners, and people trust it to deliver the products they want and need for their pets.

In the fiscal third quarter (ended Oct. 29), 76% of net sales on Chewy.com came from its Autoship service, and that number is growing. The Autoship feature works out well for both customers and Chewy. Customers get a discount for automating their purchases of certain items on a consistent schedule. And Chewy benefits from the ability to easily predict inventory needs, reducing its shipping expenses by combining all items into a single shipment, and increasing customer revenue retention.

That last number exceeds 100%. In other words, Chewy customers spend more every year they shop with the company. That certainly speaks to the brand loyalty Dunlop finds attractive.

Not only does Chewy boast a good moat in its industry, but the industry is also growing quickly relative to the rest of retail. Chewy's management expects spending on pets to grow between 5% and 7% annually over the next five years. Meanwhile, e-commerce will continue to take a larger portion of that pie, growing from 36% this year to 45% or more in the long run. If Chewy simply keeps up with the industry, instead of taking share, it'll support the "high-single-digit" long-term annual revenue growth management guided for at its investor day in December.

Why Chewy stock could more than double in price

Dunlop doesn't think sales growth for Chewy is going to blow anyone's socks off in the near future. In fact, he sees sluggish growth of just 3.5% in fiscal 2024 before it reaccelerates in the back half of the decade to meet management's long-term outlook.

The upside at Chewy comes from margin expansion. He sees the company's operating margin expanding from essentially breakeven today to 7.8% by 2032.

Chewy's already done a great job of showing operating leverage and improving its high-margin sales. Gross margin climbed from 20% in 2018 to 28% today. Several factors could drive margin higher over the next 10 years.

  • Advertising: Chewy's advertising business is just getting started. Sponsored listings and products have a high gross margin and can exhibit very strong operating leverage at scale.
  • Chewy Health: Chewy's pharmacy and telehealth business has higher margins than selling pet food and toys, and it's growing faster than the core retail operation. Software solutions for veterinarians such as Rhapsody and Practice Hub can produce very high economies of scale.
  • Private brands: Leveraging its retail brand to make private-label products can increase customer loyalty while driving gross margin higher. Management is targeting 15% sales penetration long term, up from mid-single digits today.
  • Scaling logistics and automation: Growing Authoship sales allows for more automated fulfillment centers. Growing orders allows Chewy to leverage its expanding fulfillment network and utilize the space more efficiently.

Combine all these factors, and Dunlop sees Chewy growing revenue 8.1% per year on average over the next 10 years with operating margin reaching 7.8%. Dunlop previously suggested Chewy stock should trade for an enterprise-value-to-forward-sales ratio of 1.5, but shares currently trade for less than 0.6 times Wall Street's consensus estimate. That's an attractive valuation for a dominant company in its industry like Chewy.