Should You Buy The Dip in Chewy (CHWY)?

Pet ownership has seen incredible growth in the past year and a half.  This was brought on by the pandemic buying craze, as people felt increasingly isolated by the virus lockdowns. 

However, recently stocks in the pet industry have seen a pull back, as evident by the 2.5% drop in the ProShares Pet Care ETF (PAWZ) during the last month. One of the pet stocks that has been hardest hit is Chewy Inc. (CHWY), which has dropped more than 7.5% since it reported earnings on September 2nd.

Chewy, Inc. is an online seller of branded and private-label pet food and grooming supplies. CHWY’s bands include A Pet Hub, A&E Cage Company, ABO Gear, Acurel, Addiction, Advance, Advantage, Apocaps, Atopia, Audubon Park and Ark Naturals.  CHWY offers over 1,600 brands with its operations in 13 locations, its Website, and mobile applications.

Today I’ll take a look at CHWY to determine whether this dip constitutes a buying opportunity.

Since the beginning of the year, the stock price of CHWY has fallen 18%, massively underperforming the S&P 500 which is up 18.8%.

While CHWY net sales surged in recent months, its profitability remains restrained

CHWY has benefited significantly from the pandemic, as more and more customers purchased pet food and other products during the lockdowns. The company’s fundamentals were enhanced by this trend, with CHWY’s top-line growth expected to jump 47.4% to $7.14b in 2021. Nevertheless, analyst expectations for net sales remain high for the following years, with net sales expected to advance by 25% to $8.95b in 2022 and by 20.6% to $10.8b in 2023. 

In spite of the high growth, the company’s bottom line has worsened in 2021 and is expected to report a net loss of $925m in 2021, compared to a loss of only $252m in 2020. Going forward, CHWY should turn things around in 2022 and the company should deliver a net profit of $407m, corresponding to a net margin of only 0.45%.

On the bright side, the company has lifted its net cash position since 2020. Indeed, CHWY is anticipated to finish 2021 with a cash position more than twice as high as last year, establishing at $563m. Besides and while the company has reduced its CAPEX by 73% in 2021 to $131m, the pet specialist should deliver a positive free cash flow of $201m in 2021.

CHWY is betting on pet health services to boost its long-term growth, but valuation metrics are excessive. 

CHWY has announced earlier this year the creation of a marketplace, Practice Hub, that will allow its customers to get direct access to veterinarians, enabling the company to propose an expanded range of health services which will drive its long-term growth. Through this platform, the company will have an entire ecosystem where they sell pet products but also prescription medicines, which should enhance CHWY’s value proposition. 

In spite of this and even if CHWY’s stock price dropped considerably after the high reached at the beginning of the year, the pet retailer’s valuation metrics are still overly stretched. With a 2022e EV/EBITDA of 89.8x and an enormous 2022e P/E ratio of 1133x.

Take Away

Online retail has benefited greatly from the pandemic and with the added benefit of an uptick in pet owners, Chewy has received a pandemic boost. Even though CHWY has a very high P/E ratio, it is a company that is growing quickly in an industry which is expected to see a growth rate of 5.6% in the 2021-2028 period.

In addition, Brian Fitzgerald of Wells Fargo has given Chewy a bullish price target of $110 citing Chewy’s Prescriptions platform could “drive improved health-care compliance among pet parents and multiple potential revenue opportunities for CHWY and its health-care partners over time.”

The average price target on Wall Street is $95.79 or 30% higher than the current price of the stock, representing a substantial upside for investors.

As Chewy continues to build their brand and customer loyalty while also working to lower operating expenses, I believe the stock is a long-term buy for investors.