Chewy (NASDAQ:CHWY) stock has been on fire in 2020, at one point rising as much as 140% year-to-date on the back of abundant investor optimism that the company is the midst of pioneering a future wherein we buy all of our pet food and toys online.
This optimism is not misplaced.
Pet shopping is moving online at a rapid pace. This shift is not temporary. It is permanent. And Chewy is the Amazon (NASDAQ:AMZN) of this pet food and supplies market.
To that extent, Chewy stock is a long-term winner.
Yet, shares have come under tremendous pressure amid the recent tech stock selloff. As of this writing, the stock has fallen about 25% over the past two weeks.
Do not stress this selloff. It’s nothing more than a natural setback after a red-hot rally. Embrace the weakness in CHWY and buy stock on the dip.
Here’s a deeper look why.
CHWY Stock: Young Folks are Becoming Obsessive Pet Parents
As a young pet parent myself, I can tell you that there is a whole generation of millennials and Generation Z folks out there who are pushing back big life events, becoming pet parents, and treating those dogs and cats as starter children, buying them the best-of-the-best of everything, from food to vet treatments to toys.
More than 70% of millenials are pet owners. Around 67% of millennials see their pets as part of the family and call them “fur babies” or “starter children”. And these obsessed millennial pet parents spend just under $1,300 per year on their pet.
As a result, the U.S. pet foods and supplies market has sustained strong and stable 4% sales growth per year over the past several years.
This growth trajectory will sustain for the foreseeable future, as more and more millennials turn into obsessed pet parents willing to open their wallets to give their pets the best lives possible.
Of course, this is a positive trend for Chewy’s stock.
These Young Pet Parents Prefer DTC Shopping Channels
Of particular importance to Chewy, all these young pet parents grew up in a world of Amazon, and consequently, are super familiar with and prefer online, direct-to-consumer (DTC) shopping channels.
According to a 2020 eMarketer survey, around 50% of 25- to 34-year-olds do at least half of their shopping online. More than a quarter do all or almost all of their shopping online.
Yet only 14% of pet foods and supplies were bought online in 2017.
This delta between the current status of the market — 14% e-commerce penetration — and the preferences of the majority of the new buyers in the market — 50% of young consumers do at least half of their shopping online — implies huge growth potential for the online pet foods and supplies market.
Huge growth in that market implies huge gains ahead for CHWY.
Chewy Is the Amazon of the Pet Food & Supplies Space
For all intents and purposes, Chewy is the Amazon of the pet food and supplies space.
Chewy.com is the biggest online pet foods and supplies platform. Shipping times are ultra fast. Shipping is free on orders over $49. The platform has great brand equity, awareness and recognition. The inventory is seemingly endless. Prices are affordable. There are expert advice videos. There’s also an online pharmacy.
In other words, Chewy truly has created an end-to-end, all-in-one online store for all your pet care needs.
Chewy belongs in that category, which strongly implies that Chewy stock has significant long-term upside potential as the platform transforms into the Amazon for pets one day.
There’s Valuation Upside for Chewy Stock on the Dip
The one problem with CHWY stock two weeks ago was that it was overvalued.
That’s no longer the case. Following its 25% slide in the past two weeks, CHWY is now fairly valued, meaning this is a great time to buy stock on the dip.
My assumptions on Chewy are pretty straightforward:
- The U.S. pet foods and supplies market sustains historically average ~4% compounded annual growth into 2030, supported by obsessive young pet parent (over)spending.
- E-commerce penetration rates in the space soar to 40%-plus, equivalent to where they are in other easily digitized retail verticals like consumer electronics.
- Chewy sustains strong leadership position in the market, with market share hovering north of 50%.
- Profit margins expand with scale, and EBIT margins round out to nearly 10%.
Under those assumptions, I see Chewy doing about $4.50 in earnings per share by 2030. It’s easy to see the stock fetching a 25-times forward multiple at scale. Based on a 25-times forward multiple and an 8.5% annual discount rate, $4.50 in earnings per share by 2030 implies a 2020 price target for the stock of nearly $55.
Thus, Chewy is no longer overvalued. It’s now fairly valued, meaning the recent selloff in CHWY is a longer-term opportunity for stock holders.
Bottom Line on CHWY Stock
The future of buying pet foods and supplies is online, and in that future, Chewy turns into a mini-Amazon for pet owners.
To that end, Chewy is a long-term winner, and near-term weakness is nothing more than an opportunity. Buying the dip here and now looks like the smart move considering the favorable economic backdrop and relatively discounted valuation.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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