Chewy Stock: Is the Recovery Real?

For the second consecutive quarter, chew (CHWY -0.52%) shares rose relative to earnings.

Shares of the online pet products seller rose 11% on Wednesday after it reported modest revenue growth in the second quarter, but profits rose as it delivered strong margin growth.

Revenue rose 2.6 percent to $2.86 billion, in line with estimates, while adjusted earnings per share rose from $0.15 to $0.24, ahead of the $0.01 consensus. This is the third quarter in a row that the company has smashed earnings estimates.

Bottom line growth was paced by its gross margin, which expanded 120 basis points in the quarter to 29.5%. The company credited the improvement in its business growth to higher margins, better pricing and staying competitive in key categories.

Chewy also made improvements in operating expenses, which fell 50 basis points as a percentage of revenue from 28.9% to 28.4%. Operational efficiency is improved, with 40% of order volume now automated.

As a result, adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) increased 190 basis points to 5.1%, or $145 million in adjusted EBITDA.

Image source: Getty Images.

The margin improvement is impressive, but…

Chewy deserves credit for expanding its margin, but all is not well in the business.

Its revenue growth has slowed for the past seven quarters in a row through its most recent report, reaching just 2.8 percent in the second quarter. Customer growth also stagnated as total customers reached 20 million, which was essentially flat from the year-ago quarter.

The pet e-commerce leader ended fiscal 2021 with 20.7 million active customers, which declined to 20.4 million in fiscal 2022 and 20.1 million in fiscal 2023. Currently, Chewy is on track for its third consecutive annual decline in active customers.

Chewy was able to grow net sales per active customer, a credit to its ability to expand relationships with its current customer base as it invests in repeatable categories and adds new premium product lines, but the business would be healthier with customer growth.

The pet products industry has struggled since the end of the pandemic due to the increase in pet adoptions during Covid. Chewy also benefited from the pandemic as an e-commerce company as consumer spending shifted to the online channel.

Chewy forecasts revenue growth of 4% to 6% for the year, but that includes an extra week on the calendar, meaning growth would be just 2% to 4% without it.

The biggest question facing Chewy

Shares of Chewy have now practically doubled from this year’s low point, and based on its quarterly results, the stock looks reasonably priced, especially if it can report more quarterly earnings results like the one it just did.

Based on its forecast of $538 million in adjusted EBITDA for this year, the stock is valued at 21 times this year’s estimated EBITDA.

Chewy’s business also has a number of attractive attributes, including its self-delivery customer base, which provides a highly predictable revenue stream and is the clear leader in pet retailers.

However, the biggest question right now is whether the company has hit a ceiling in customer growth. Three years of declining customer base looks like a red flag, even taking into account the pandemic’s carry-forward effect.

Peers like it Petcowhich also grew during the pandemic, is struggling now, and Petco’s revenue fell 1.7% in its most recent quarter. Other pet food companies such as Freshpethowever, they continued to produce strong growth.

Chewy’s management seems to believe that the long-term growth trend in the e-commerce sector will continue and said that traffic to the site is returning to growth.

Right now, if Chewy can return to reasonable growth, the stock looks like a buy based on its bottom line improvements. For now, however, investors are better off on the sidelines until the company can prove it can grow its customer base again.