People are paying more for their pet supplies these days. In late March, Chewy (CHWY -1.20%) announced record average annual spending as part of its fiscal fourth-quarter earnings update. Gains here allowed the e-commerce specialist to offset weaknesses in other areas of the business so sales could rise 10% in 2023.
Yet the stock's drop in recent months shows how Wall Street is more concerned with Chewy's weakening growth prospects. These are best reflected in changes to its active customer pool, which is a trend that investors will want to watch when considering whether to buy this stock on the dip.
Let's take a closer look.
The good news
Chewy's Q4 update (covering the selling period through late January) had some good news for shareholders around growth. Existing customers were highly engaged, for example, with its subscription-like delivery service accounting for a record 76% of sales (up from 73% a year earlier). Chewy was also able to raise prices at a healthy clip last year as average annual spending jumped 12% to $555 from $496 in 2022.
These wins suggest the company is delivering lots of value to pet owners right now. Management estimates that Chewy won market share last year, even as the pet supply industry contracted. It sees room to set more records on annual spending, too, with help from Chewy's push into the pet healthcare niche.
The troubling metric
Yet Chewy's growth hangover is far from over. Pet adoption rates are stuck below their pre-pandemic levels following a spike during 2020 and 2021, and this factor is making it much harder to win new shoppers. Instead, Chewy's customer pool shrank by 1.6% in 2023 after falling by 1.2% in the prior year. It's hard to see a path back to sustainably strong sales growth that doesn't feature a return to robust customer gains.
Don't expect those gains to come in 2024. Management said in a shareholder letter that this fiscal year will be unusually weak for the industry, thanks to weaker demand coupled with slower price hikes. It projects the industry should return to its more normal pace of roughly 6% to 8% annual growth starting in 2025, but not before another year of below-average gains. Chewy is expecting to win market share this year either way.
Looking further out
Investors can expect to see good progress in some important financial and operating metrics this year. Chewy reported much stronger cash flow in 2023, for example, and gross profit margin is at a record 28% of sales. Wins here should pave the way for even higher cash flow and soaring earnings once the pet supply market emerges from its current funk.
Investors should keep a close eye on Chewy's customer pool, though, which might decline for a third consecutive year in 2024. Sure, higher average spending will help offset these declines as the retailer widens its merchandise selection. Yet Chewy needs the lift from rising customer traffic on its platform to sustain growth into 2025 and beyond.
Investors haven't seen a stabilization in the active customer pool yet and are bracing for the possibility that losses will accelerate this year. On the other hand, a surprise rebound in this metric would likely spark a rally in a growth stock that's down over 80% from its pandemic peak valuation.
