Chewy: Just turned profitable, does it make it a buy?

Chewy just had its first profitable year. They have a 41% market share in a market that is expected to grow by an 8% compounded annual growth rate. Additionally, they are exploring new higher margin segments to enhance profitability in the future. Furthermore, I write this because the stock is currently trading well below its previous high of $118 it reached in February 2021. It all sound good, but does it make the stock a buy? It is something I will investigate in this analysis.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

This analysis will be a bit different from what you are used to read in my blog. Chewy did their IPO in April 2019, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.

Before I begin the analysis, I should mention that I do not currently own any shares in Chewy. This means that I have no personal stake in the company. If you would like to view or copy my portfolio, you can find instructions on how to access it here. As always, I will keep this analysis unbiased. If you want to purchase shares or fractional shares of Chewy, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.

Chewy is an American e-commerce company that sells pet food, treats, pet supplies, and pet medications. Chewy partners with over 3.000 brands in the pet industry and offers more than 100.000 products. Since January 30, 2022, they have also been offering expanded services, such as "Connect with a Vet" telehealth for veterinary care and the largest pet pharmacy in the United States. They have an extensive infrastructure, which means that they can serve over 80% of the U.S. population overnight. Most of their sales (73%) come from their auto-ship scheme, which is a type of subscription where customers receive products automatically every month until they actively cancel the subscription. Chewy has experienced rapid growth and currently holds a 41% market share in their respective industry. Furthermore, Morgan Stanley expects the pet industry to experience an 8% compound annual growth rate (CAGR) until 2030. However, despite having a 41%market share and operating the largest pet pharmacy in the United States, I don't see Chewy as having a strong moat. However, as 73% of their sales are through subscriptions, it could indicate that they are slowly building a moat.

Their CEO is Sumit Singh. He joined Chewy in 2017 as the Chief Operating Officer (COO) and became the Chief Executive Officer (CEO) in 2018. Before joining Chewy, Sumit Singh held senior leadership roles at Amazon and Dell.He holds a master's degree in engineering from the University of Texas and an MBA from the University of Chicago. Besides being the CEO and serving on the Board of Directors at Chewy, he also serves on the Board of Directors at Booking Holdings. He was named to the Bloomberg 50 in 2020, which is a list of innovators, entrepreneurs, and leaders who have transformed the global business landscape. In 2020, he was also on the list of Comparably's best CEOs. Under his leadership, Chewy has been named as the "2022 Best Place to Work" by Built In, while Newsweek has named Chewy to the list of "America's Best Customer Service" for the last four consecutive years. As we will see later in the analysis, he has also delivered good results by tripling revenue in the last four years. All in all, I feel confident that Sumit Singh is the right person to lead Chewy forward.

I don't think that Chewy has a moat yet, but they could build one in the future. I really like the management. Later, I willdo a discounted cash flow model to calculate a price for Chewy. But before I do so, let's take a look at some key financialmetrics.

Below, we will examine some key financial metrics for Chewy over the past three years. Chewy's fiscal year ends at the end of January. Thus, the numbers from 2023 cover the period from 01-02-2022 to 31-01-2023. It is worth noting that revenue has grown every year, which is always positive. However, growth has eased as Chewy only managed a 13,6% growth compared to 24,4 % in 2022 and 47,4 % in 2021. Gross profit margins have increased every year, which is very nice to see. 2023 marked a significant milestone for Chewy as they achieved a positive operating income. This is a positive development, although the operating margin remains relatively low. Net income was positive in 2023 for the first time ever, as was EPS, which is nice to see. EBITDA and EBIT were also positive for the first time in 2023, but margins still leave a lot to be desired. Hence, top-line growth is slowing down, but the bottom line is positive for the first time. I would like to see much higher margins in the future, but these numbers suggest that Chewy is on the right path.

Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of Chewy. The number of active customers isn't growing as fast as it was before. Chewy has been steadily growing its customer base over the years. However, from fiscal 2021 to fiscal 2022, Chewy only managed to grow its active customer base by 0,6 %.Furthermore, Chewy's active customer base decreased in the fourth quarter of 2022, going from 20,5 million active customers in Q3 to 20,4 million customers in Q4. While it wasn't a significant decrease, it is concerning when a growth company fails to expand its active customer base. Competition. Competition is a risk factor when a company does not have a strong competitive advantage. Furthermore, Chewy mentions in their annual report that the pet products and services industry is highly competitive, as they face competition from a wide range of competitors. In the annual report, they mention that competition is particularly strong within the e-commerce channel as the industry continues to experience a secular shift from in-store to online shopping. They operate in a low-margin sector. Retail and e-commerce are historically low-margin businesses that require a large amount of scale to generate significant operating leverage. As we saw in the financials earlier, Chewy hasn't yet been able to demonstrate a significant operating leverage, as their operating income has just turned positive. And even if they manage to scale their business to generate operating leverage, it still won't be a high-margin business. Just look at Amazon, which makes its profits (when it is profitable) from AWS.

There are also potential opportunities for Chewy moving forward. Higher net sales per active customer. While the number of active customers is not growing as fast as desired, net sales per active customer are growing steadily. In fiscal year 2022, net sales per active customer grew by 15% compared to the previous year, reaching $495 in 2022, which is up by 15%. This represents an increase of $65 compared to the previous year. Interestingly, Chewy mentioned that their three oldest cohorts of customers spent $1.000 a year. This indicates that the longer they have been customers, the more they spend. And nearly 60% of all Chewy's customers have joined in the last three years. In the last earnings call, management mentioned that they believe "there is still a tremendous opportunity for us to fully unlock the revenue potential of our existing customer base." New vertical integrations. New vertical integrations could potentially enhance profits and margins in the future. Chewy Health is still in the early stages, and management mentioned in the earnings call that they see it fueling growth and increasing margins. Management also discussed other vertical integrations in sponsored advertising and insurance. Chewy has already released its beta version of sponsored advertising and expects to have it live in the first half of 2023.Management mentioned that they will quickly ramp up online advertising, and as we know, advertising has high profitmargins. Insurance takes a longer time to build, and management believes it can take up to three years until it can contribute meaningfully. However, if they succeed, it will also increase margins. International Expansion. Management plans to launch their first international market in the next few quarters. When Chewy expands internationally, it will grow its total addressable market. Management mentioned in their last earnings call that their international expansion will be organic, rather than through acquisitions. They also stated that they took into consideration factors such as the size of the total addressable market, geographic proximity, and similarities in consumer behavior with the U.S. when deciding on international expansion. These factors are expected to increase the likelihood ofsuccess.

I have now investigated the financials, risks, and potential of Chewy. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2023 figures, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to go with a middle option. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the highest option due to the current market conditions. Remember that all the numbers used in these calculations are in millions.

I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. I decided to use an EBIT growth rate of 20% year over year. It might be too high for some and too low for others. The EBIT growth has been 54% year over year for the past 5 years, but as we have observed, the growth rate is slowing down. I calculated a growth rate of 15% per year for Depreciation & Amortization, which is slightly lower than the growth rate for EBIT. The average growth of Depreciation & Amortization over the last 5 years has been 46,5 %.Finally, I decided that Net Working Capital will grow at 10%. I haven't found a smart way to share all my spreadsheet here, but once I did my calculations, I found that the intrinsic value of Chewy is $37. And you would probably like a 50%discount on that.

Having investigated Chewy, I find the lack of a moat slightly concerning. However, I feel confident in the management, and they may be able to build a competitive advantage moving forward. I find it a little concerning that the number of active customers is not growing, despite the fact that the net sales per customer are growing. Their customers will eventually reach a saturation point where they cannot spend more. That is why it is crucial for them to attract more activecustomers, which can be achieved through international expansion. I'm not impressed with the margins that Chewy delivers. However, if they manage to achieve success in their new vertical integration, margins could potentially expand significantly. However, until I see evidence of these new vertical integrations resulting in higher margins, I will refrain from opening a position in Chewy.

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