I’m a big fan of Chewy (NYSE:CHWY). My household was an early adopter of the service and at this point no doubt qualifies as a “power user.” I bought CHWY stock not long after its June 2019 initial public offering and added to my stake on weakness later that year.
I’m still a big fan of Chewy as a business. But I’m not so upbeat on the stock. In fact, I sold my CHWY stock last year. And while I sold early — like so many owners of so many winning stocks in recent years — I’m still worried about the company’s long-term outlook.
Chewy has a great business. It’s in an attractive industry that has plenty of potential for growth. But its business is now valued at $35 billion. That’s a number that looks awfully high, even to a big fan of Chewy like myself.
Sticking With Growth
In the context of recent history, it’s dicey to make the case that a solid growth play is “too expensive.” For years now, the market has made clear that growth is more important to it than valuation.
Whether that’s because a stock market bubble is nearing or because investors are properly taking the long view (I think the latter explanation looks more accurate), it’s a trend that hasn’t broken yet.
And it’s a trend that suggests that investors should be optimistic toward CHWY stock. After all, Chewy’s revenue jumped 47% in fiscal 2020. And the company took a big step toward quieting concerns about its profitability. Its EBITDA (earnings before interest, taxes, depreciation and amortization), excluding certain items, was nicely positive for the year. Chewy even posted a surprise net profit in the fourth quarter.
Chewy’s growth is going to decelerate simply due to its size. But the company retains enormous potential. As Chewy put it in its Q4 shareholder letter, it “is clearly only scratching the surface of the overall market opportunity” in front of it.
Chewy Pharmacy is growing rapidly, with the company now moving into compounding. It also has a new telehealth offering that is part of its broader push into services. And e-commerce’s share of the core pet food category is only about 30%, leaving Chewy with more customers to acquire.
On top of all that, the novel-coronavirus pandemic led to a flood of pet adoptions. Thanks in part to that boost, Chewy picked up nearly 6 million customers last year alone. Those customers aren’t going anywhere; in fact, Chewy’s history suggests they will only spend more and more money on the company’s website over time.
A “Pandemic Winner?”
Given the company’s performance and outlook, the correct trade in recent years has been to go long and stay long CHWY stock. Many of the best stocks of recent years looked expensive all the way up, including names like Shopify (NYSE:SHOP) or Tesla (NASDAQ:TSLA). Why should Chewy be any different?
But at the moment, there is one exception to the “growth at almost any price” sentiment: So-called “pandemic winners” have struggled of late. Zoom Video Communications (NASDAQ:ZM) is well off its October highs, while DocuSign (NASDAQ:DOCU) has been flat since July. Before a recent breakout, the same was true for Amazon.com (NASDAQ:AMZN).
CHWY stock itself has pulled back in recent weeks, even after its strong Q4 results.
A rotation to the so-called “reopening trade” might be one factor behind the weakness of those stocks. But they also have pressures on the way, thanks to the combination of a return to normalcy this year and difficult comparisons from last year’s results.
Chewy simply isn’t not going to grow at the same clip this year as in 2020. Again, its newly acquired customers will help, as will its new initiatives. But the tailwind of lockdowns and pet adoptions won’t be repeated.
And those issues won’t necessarily end this year. It’s worth noting how significant Chewy already is in the pet business. Figures from its Q4 shareholder letter suggest that the company already has about 7% of the entire U.S. pet market. That includes services and veterinary care, which account for 40% of the $104 billion market.
There will be, however, a ceiling on Chewy’s growth coming at some point, at least in the U.S. That could make investors a bit concerned about the longer-term outlook of the company, whose business in the short-term at least won’t look quite as impressive.
What’s Priced Into CHWY Stock
After the recent retreat of Chewy’s shares, it’s reasonable to argue that these relatively minor concerns are priced into the stock. But I’m not completely sure that’s the case. It’s still trading at nearly five times its trailing revenue. That might not sound like a lot in a market where multiples of more than 20 times revenue are almost common.
But Chewy isn’t a software company with gross margins above 80%. Its gross margins in FY20 were just 25.5%. CHWY stock is changing hands for 19 times its gross profit, putting Chewy’s valuation toward the high end of the market. And the shares are trading for over 300 times its expected earnings per share, excluding some items. That’s obviously far from cheap.
Chewy’s valuation suggests that it has a very good business that’s going to grow nicely in the coming years. I believe that’s an accurate forecast. But it’s harder to predict whether the company can grow faster than the pace reflected by its share price. At the very least, it does seem like the easy money has already been made from CHWY stock.
On the date of publication, Vince Martin held a long position in AMZN.
