What the Smartest Investors Know About Chewy Stock – The Motley Fool

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Pet owners love their pets and increasingly treat them like family members, which is exactly the trend that Chewy (CHWY -1.44%) has been tapping into these days. So far, the story has been about building out the online retailer’s business, but it appears that 2022 could be an important turning point for the company. Investors should pay close attention because there’s a core customer group that has been instrumental to this success.
Chewy held its initial public offering (IPO) in mid-2019, having been spun off from physical pet store retailer PetSmart, which is a private company. The first year a company is public is often a chaotic one when it comes to its financial statements, so it isn’t surprising that Chewy’s net income was deeply negative in 2019.
In 2020, the net loss narrowed dramatically and 2021 saw a further, though much less dramatic, narrowing of the red ink. The key focus for the company and investors was the top line, where sales have been growing at a rapid clip. This is not an unusual pattern for a newly public company.
Image source: Getty Images.
The big question is, will the company be able to eventually turn a profit? It appears that 2022 could be that year for Chewy. Through the first nine months of the year the company’s net income is around $43 million compared to a loss of a touch over $10 million over the same span in 2021. The retailer’s earnings per share through the first three quarters is around $0.10.
Given that the fourth quarter tends to be strong for retailers as consumers buy for the holiday season, it seems quite likely that Chewy ends 2022 with its first full-year profit. This is an important inflection point, allowing investors to better analyze the stock. Per-share losses render many valuation measures (such as the price-to-earnings ratio) useless, for example.
So, from a big picture perspective, Chewy’s business is doing pretty well right now. But don’t stop there when you look at the company because there’s a top-line nuance that smart investors are watching very carefully. The company prides itself on high-quality customer service that drives repeat business.
In fact, the company’s “about” section specifically states: “Chewy’s commitment to customer service is the core of our brand, and our customers love us for it. We ‘WOW’ pet parents through 24/7 assistance, advice and encouragement every day of the year.” Try finding a human being to help you with pet decisions at Amazon.com.
This helps explain why Chewy can report that 73.3% of its top line comes from “autoship” sales. Essentially, these are pet owners (or pet parents, if you prefer) who have things like food automatically sent to them at regular intervals. This is a huge benefit, because these customers are pretty much locked in. To change to another pet retailer, they need to actively do something (stop autoship).
That’s a surprisingly high hurdle for a lot of consumers (it’s why subscription services like Netflix are such a big deal). Meanwhile, Chewy has a clear line of sight regarding the products it needs to buy and when, helping it to streamline its ordering and fulfillment efforts. It’s almost like an annuity business, and given the 73.3% number, it can be seen as a huge competitive advantage.
The problem is that Chewy isn’t the only retailer that offers such a service, given that it isn’t exactly hard to set up an autoship program. Amazon has one and so does direct competitor Petco Health and Wellness. And the pet food niche of the consumer staples space is highly competitive. If other suppliers start to compete more aggressively on price, especially in an economic environment featuring high levels of inflation, competitors might be able to chip away at Chewy’s loyal autoship customers. 

CHWY PS Ratio data by YCharts
This isn’t meant to suggest that Chewy’s business model is at risk; that doesn’t appear to be the case. However, it does rely heavily on a select group of customers continuing to do the same thing that they have been doing. That’s why smart investors monitor autoship.
If something changes and Chewy can’t rely on these repeat customers, its financial results could turn in the wrong direction. And if that happens, the premium valuation it is being afforded relative to peers might quickly narrow. To put a number on that, Chewy’s price-to-sales ratio is currently around 1.6 times versus just 0.4 for Petco.
Don’t just assume that Chewy’s core customers will always remain loyal. Intense competition, like there is in the pet niche, can lead to quickly changing industry dynamics. Check the autoship statistics every quarter to make sure Chewy’s business remains on the growth track.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon.com, Chewy, and Netflix. The Motley Fool has a disclosure policy.
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