Chewy is the Right Company, Trading at the Wrong Price

U.S. pet e-commerce category leader Chewy (NYSE:CHWY) has been on fire this year, with CHWY stock up nearly 70% year-to-date.

Why Chewy Stock Looks Really Compelling Ahead of Earnings
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Amid physical retail shutdowns thanks to the novel coronavirus pandemic, consumers have flocked en masse to online retail channels. This led to significant sales growth acceleration on Chewy’s online pet products platform in March, April and May. Management consequently guided for first-quarter sales growth of nearly 40% (versus about 35% growth in the fourth quarter).

On the idea that this acceleration is not temporary, investors have pushed Chewy stock to all time highs.

Investors are right. This acceleration is not temporary. Covid-19 has permanently accelerated the online retail revolution.

And Chewy is the unparalleled leader in an under-penetrated e-retail category, with tons of room to grow over the next several years through: 1) further e-commerce penetration in U.S. pet food and supplies sales, 2) e-retail market share gains, 3) higher spend per customer, and 4) increased scale driving margin expansion.

In other words, Chewy is the right company.

But CHWY stock is trading at the wrong price. That is, at current levels, CHWY stock is too expensive for its own good.

And for that reason, don’t chase the rally. Instead, monitor the stock. Let the hype fade a little. Let the stock come down. Then buy the dip.

The Right Company

The long-term growth narrative underlying Chewy stock is very compelling.

Americans love their pets. This has never been more true than today, with Generation Z and millennial couples – who are notably pushing back big life events like having actual kids – becoming pet parents in greater frequency and treating those pets as starter children.

As such, U.S. consumer spend on all things pet-related (food, supplies, vets, etc) is enormous (projected at $99 billion in 2020) and growing at a steady 3%+ clip, driven by a greater number of pet owners and higher per capita spending.

This massive and growing market is under-penetrated when it comes to e-commerce. Only 18% of pet food and supplies sales happen in the digital channel. That number stands north of 30% for apparel sales.

But the pet e-commerce wave is moving quickly. Pet food and supplies e-retail penetration is expected to surge toward 25% within the next few years, implying steady 10%+ growth for the U.S. pet e-retail market going forward.

Chewy is at the epicenter of that market, with about 50% market share in 2019. Interestingly enough, Amazon (NASDAQ:AMZN) owns 50% of the total U.S. e-commerce market.

Assuming that Chewy leverages branding, logistics and customer loyalty advantages to turn into the Amazon of the pets market, then Chewy is looking at robust 20%+ revenue growth potential over the next several years.

Alongside that robust revenue growth, profit margins should improve with scale, and profits should storm higher by a lot more than 20%+ per year.

Net net, Chewy is a long-term winner, with big tailwinds, and huge long-term profit growth prospects.

The Wrong Price

The only problem with Chewy stock is that it’s already priced for all that big growth.

For a moment, let’s look at some other leading e-commerce players. Wayfair (NYSE:W) – the leading e-furniture company. Revolve (NYSE:RVLV) – the leading social e-commerce company. (NASDAQ:JD) – the “Amazon” of China. Stitch Fix (NASDAQ:SFIX) – a revolutionary, online apparel styling service. Carvana (NYSE:CVNA) – the leading online used car retailer.

All of those stocks trade around 1 to 2 times sales.

CHWY stock, by comparison, trades at 4 times sales.

Sure, some of that premium is warranted by the fact that Chewy has bigger profit growth prospects than many other e-commerce companies, given the aforementioned favorable fundamental drivers.

But not all of it.

Consensus 2024 earnings estimates sit around 50 cents per share for Chewy. I think that, assuming Chewy can turn into the Amazon of a U.S. pet e-retail market that drives toward 30%+ e-commerce penetration, the company could grow earnings toward $3 per share by 2030.

Even so, that’s not enough growth to warrant today’s $50 price tag.

Consumer discretionary stocks normally trade around 20 times forward earnings. That “normal” multiple on $3 in earnings per share implies a long-term price target of $60, which is only narrowly above where shares trade today.

Bottom Line on CHWY Stock

Chewy is the right company to own for the long haul. But CHWY stock is currently trading at the wrong price.

Over the next few months, as Covid-19 hysteria fades, the online sales frenzy cools off and the physical economy re-opens, investors will likely pile out of the “stay-at-home” trade, sending CHWY stock lower.

That sell-off will be the time to buy. Not now.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long AMZN, JD, and SFIX. 

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