Chewy: The Ship Is Steadying

seekingalpha03-22

Chewy's stock price has fallen over 50% due to slower growth, but strong Q4 results and a focus on bottom-line leverage suggest a near-term rebound.The Company's modest valuation and expected adjusted...

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Chewy (NYSE:CHWY) springs immediately to mind in this category. The online pet e-tailer has suffered from poorer growth over the past year, contributing to more than a 50% slide in its share price. Still: with Chewy releasing strong Q4 results and issuing its outlook for FY24, there's reason to believe in a near-term rebound. Data by YCharts The big factor that is powering a potential turnaround in Chewy: the company is successfully turning the narrative away from its slower growth trajectory, pinning most of it on market conditions and still being able to point to market share growth. Instead, the company is focusing more on its bottom-line leverage, as the company leverages both the largesse of its recurring shipment base as well as tight opex controls to generate profit growth. I wrote a bullish article on Chewy back in early February, pre-Q4 earnings. After parsing through the company's latest results, I remain quite bullish on the company's prospects for the remainder of the year. The biggest draw to Chewy remains its modest valuation. At current share prices near $18, Chewy trades at a market cap of just $7.65 billion. After we net off the $1.13 billion of cash on Chewy's most recent balance sheet, the company's resulting enterprise value is $6.52 billion. Meanwhile, for the current fiscal year FY24, consensus is expecting Chewy to hit $11.69 billion in revenue, or 5% y/y growth; which is in line with the company's guidance range of 4-6% y/y. The company is also expecting 50bps of adjusted EBITDA margin leverage, hitting a 3.8% margin this year and implying $444.3 million of adjusted EBITDA: Chewy outlook (Chewy Q4 shareholder letter) This puts Chewy's valuation multiples at:  0.6x EV/FY24 revenue 14.7x EV/FY24 adjusted EBITDA  Here's a refresher as to the longer-term bull case drivers for Chewy:   Beloved consumer brand that is a clear category leader. Chewy has built up quite a lot of brand equity around being a very customer service-oriented company. This has helped the company build up a base of more than 20 million active customers, many of whom have their orders on autoship plans.  Canada's expansion is underway; future countries are still in scope. So far, Chewy has been primarily a U.S. company, but pet ownership is a worldwide market. Chewy launched in Canada in the third quarter of 2023, and future country expansion can continue to widen Chewy's overall TAM.  Margin expansion was driven by expanding product categories. Chewy's push to grow its own brand (Tylee's), plus focus more on selling higher-margin hardgoods, has proven very effective at producing margin expansion. Gross margins have recently expanded to ~29%, vs. low-20s at the onset of the pandemic. In addition, Chewy's success at passing on price increases to its customers has allowed it to preserve this gross margin progress even in the current inflationary environment.  Constant product innovation. More to the point above, the company recently also launched its own pet wellness brand \"Vibeful,\" which gives it access to a pet health and wellness TAM that it sizes at $2.4 billion alone.  Nascent opportunities in pet telehealth and pet insurance. The craze in telehealth and doctor consultations via your mobile device is spilling over into the pet world, too. The company's \"Chewy Health\" offering has built out a \"Connect With A Vet\" service, and it also has rolled out a pet pharmacy as well. In August, the company rolled out its \"CarePlus\" pet insurance plan, which was recently bolstered through a new partnership with Lemonade's (LMND) pet insurance vertical. This is a broad, new opportunity for Chewy that can both accelerate its growth and grow its margins.  Keep holding on to this stock; in my view, the company's consistency in margin expansion will help the stock grow into richer valuation multiples. Q4 download and perspectives on FY24 Let's now discuss the recent trends Chewy has been seeing. The Q4 earnings highlights are shown in the chart below: Chewy Q4 results (Chewy Q4 shareholder letter) Revenue grew 4% y/y to $2.83 billion, which came in ahead of Wall Street's $2.79 billion expectations (a 150bps y/y beat). Autoship sales, meanwhile, continued to outpace overall company growth at 8% y/y to $2.16 billion, or 76% of overall revenue. Management is noting that the pet supplies industry has entered into a phase of slower growth. Pet household formation ramped up during the pandemic, and then has since slowed down. 2023 top-line growth benefited in part from price increases (that went alongside cost inflation), which will not be a factor for FY24. The company's expectations for FY24, listed in its Q4 shareholder letter, are as follows:  Industry growth will be lower than the historical average in 2024, positioning for a stronger rebound in 2025 There will be \"no material pricing benefit\" to 2024 But in spite of industry and macro headwinds, Chewy expects to continue achieving leverage on adjusted EBITDA margins  From a gross margin perspective, the company notched a 28.2% margin, up 10bps y/y (and I'll remind here as well that pre-pandemic, Chewy's margins used to trend closer to the low 20s). Speaking to the drivers of margin improvement on the Q4 earnings call, CFO David Reeder noted as follows: We reported Q4 gross margins of 28.2% and full-year 2023 gross margin of 28.4%. On a sequential basis, Q4 gross margin decreased by 30 basis points, reflecting of the promotional calendar and peak surcharges typical for the holiday period. Gross margin for the year expanded by 40 basis points, aided by our newly launched sponsored ads initiative which had its strongest contribution in the fourth quarter of 2024. We expect continued growth from sponsored ads throughout 2024.\" Full year adjusted EBITDA margins of 3.3%, meanwhile, expanded 30bps y/y (and are expected to expand a further 50bps next year), while nominal adjusted EBITDA dollars expanded 20% y/y to $368 million. For next year, the combination of ~5% revenue growth plus 50bps of margin accretion will yield a slight acceleration to 21% y/y growth in adjusted EBITDA dollars. Key takeaways  Now that the market has settled into the narrative that the entire pet industry is facing a slower year of expansion, investors can more purely appreciate double-digit growth in Chewy's adjusted EBITDA, as well as the fact that Chewy plays in a very recession-proof industry with more than two-thirds of its revenue on an Autoship plan. Stay long here and wait patiently for a rebound.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2421363218"}