Chewed Stock: Cheap and Poised for Growth (NYSE:CHWY)

chewed (NYSE:CHWY) reported better-than-expected fiscal second-quarter earnings in late August, which went hand-in-hand with strong EBITDA margins and a favorable customer monetization trend. Chewy’s stock also re-rated much higher in FY 2024 as the company’s business fundamentals improve and a meme investor took a position in the pet e-commerce platform. I think the value proposition is still attractive here for long-term investors, despite a nearly 60% increase in the company’s valuation over the past year. The outlook is positive and the stock is not overpriced based on earnings.

Previous assessment

We recommended Chewy as a strong buy in June after the online retailer reported first-quarter earnings: A game-changing quarter (rating upgrade). In the second quarter, Chewy remained very profitable in terms of EBITDA and free cash flow and also beat the top and bottom estimates. The platform’s key metrics such as customer spend are still growing, resulting in a respectable amount of free cash flow. While I don’t expect Chewy to experience massive earnings growth in the future, I think the online pet store is doing a great job of growing its business slowly and steadily.

Solid Q2’24 results, beat earnings, stronger FCF margins

Chewy reported better-than-expected top and bottom line results for the second quarter. The pet-focused retailer posted adjusted earnings of $0.24 per share on revenue of $2.86 billion. The bottom line beat the average prediction by $0.03 per share, while the top line came in $3.0 million ahead of consensus.

Chewy continues to execute well on its growth strategy, which includes the launch of veterinary clinics, dubbed Chewy Vet Care — as a means for the pet store retailer to diversify its revenue mix and open a new line of income. Chewy remained highly profitable in the second quarter, and the pet-focused e-commerce platform generated $145 million in adjusted EBITDA in Q2’24, showing 65% year-over-year growth, as well as an EBITDA margin of 5.1%… the second highest in the last year.

Importantly, Chewy gets a good amount of free cash flow from its customer base. Because pets are a passion niche, one where customers tend to spend money on a recurring basis, I think Chewy’s free cash flow limits the risks for investors.

The company has significantly expanded its operations over the past few years, growing its product suite, focusing on improving customer monetization, as well as launching new strategic initiatives with its veterinary clinics. Improving customer monetization trends has been critical to the company’s top line and free cash flow growth in the past. In the second quarter, Chewy customers spent an average of $565 on platform products, compared to $532 in the year-ago period. In other words, platform spend per customer grew 6% year-over-year in Q2, driving top-line growth.

In terms of free cash flow profitability, Chewy has made fundamental improvements over the past few years as well and is now broadly profitable on a FCF basis. In the second quarter, Chewy generated $91 million in free cash flow, which works out to a healthy (for a retailer) free cash flow margin of 3%.

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(Source: Author)

Chewy’s guidance

Chewy’s full-year outlook calls for (NET) revenue of $11.6-11.8 billion, implying an annual growth rate of up to 6%. The online pet store also projects an EBITDA margin of around 4.5-4.7%.

Cheap evaluation

We previously mentioned Chewy as an investment opportunity, in part because of the retailer’s low valuation based on earnings. Chewy was trading at an earnings multiple of 22.6X when I last looked at the online pet retailer in June, which was significantly below the company’s historical valuation average.

Chewy stock currently trades at a price-to-earnings ratio of 25.7X, and while there’s already been a major revaluation since my last piece on Chewy was published three months ago — the stock is up 41% since then — I think the retailer still represents an attractive investment value. Contributing to Chewy’s strong performance was the fact that meme investor Keith Gill, known as Roaring Kitty, purchased almost half a billion dollars worth of Chewy stock in July.

First, Chewy trades at a 55% discount to its long-term 3-year average P/E ratio of 57.1X. Moreover, rival pet company Petco ( WOOF ) is priced at a much higher 60.7x forward P/E ratio, and the estimate trend significantly favors Chewy (see chart below) .

In my view, Chewy could trade at a price-to-earnings ratio of 30-32X, implying a fair value range of $37.35 to $39.84 for the retailer’s stock. The revaluation could be driven by further expansion into new product categories such as pet pharmacies and veterinary clinics, and potentially accelerating returns on capital given that Chewy is already generating a decent amount of free cash flow .

Risks with Chewy

The biggest risk I see for Chewy is that its core operations are highly competitive and have a low moat. Pet products are commodities and can be sold by many other companies, including Amazon, which means they tend to have small margins. Therefore, investors should not expect a drastic increase in profitability in the future. What would change my opinion of Chewy is if key performance metrics like EBITDA and free cash flow margins deteriorate or if Chewy sees a decline in its revenue base.

Closing thoughts

Chewy is not a software company whose profitability and valuation could explode overnight. However, Chewy is seeing steady growth in its core business, which has had positive results in its customer transactions (improved monetization) and an increase in EBITDA and free cash flow since last year. Chewy performed well in the second quarter, and free cash flow margins remained fairly stable year over year. I see more upside potential for Chewy related to its growing platform spend, and Chewy’s valuation remains well below its historical valuation ratio.