Chewy (CHWY 2.99%) is struggling to maintain a high growth rate as households ease off the heavy pet adoption rate seen during the height of the pandemic. While growth slows, analysts at Morgan Stanley are instead keyed into the profit story.
The analysts noted that the macroeconomic environment is a concern, but they believe the pet goods retailer will be able to boost margins despite lackluster growth. As a result, Morgan Stanley initiated an overweight rating on Chewy stock with a price target of $27. Based on Chewy's closing price on Thursday, that price target represents an upside of 70% over the next 12 months or so.
A tough environment for Chewy
Chewy grew revenue by just 4.2% year over year in the fourth quarter of 2023. Growth was dragged down by continued customer losses, which the company has been struggling with since the pandemic-era bonanza came to an end. This year won't be any better. Chewy expects muted pet household formation and no benefit from higher pricing. The company expects year-over-year revenue growth of just 2% in the first quarter, with 4% to 6% growth for the full year.
Chewy expects its active customer count to remain unchanged in 2024, with effectively all of its growth coming from higher spending per customer.
Profits are on the rise
With growth hard to come by, Chewy is starting to focus on boosting the bottom line. The company laid off 200 employees last November in an effort to cut costs, and it expects to realize cost benefits from automation initiatives this year.
The company generated $343 million of free cash flow in 2023, nearly triple what it generated in 2022. As cost-cutting efforts and the company's push into higher-margin veterinary care take root, free cash flow could rise substantially in the years ahead.
With Chewy stock trading for a reasonable-looking 20 times free cash flow, the $27 price target seems plausible if Chewy can continue to boost the bottom line.
