1 Growth Stock Down 18% to Buy Right Now

This year has been a rollercoaster ride for chew (CHWY -1.84%). The stock started the year on a downward trajectory after management said pet industry spending for 2024 would be lower than historical levels.

The stock then rallied in late May when it reported solid first-quarter sales results. Later in the summer, the stock rose when Keith Gill, aka Roaring Kitty on Reddit’s Wallstreetbets message boards, posted a photo of a cartoon dog on his X (formerly Twitter) account and then revealed a large share in the company. Gill helped spark the stockpile of memes a few years ago, but was absent from social media for the past three years before returning in May of this year.

Shares in Chewy stock are up more than 35% for the year, but down about 18% from their late June 27 high, when Gill posted the photo of the cartoon dog.

Let’s look at three reasons to buy this growth stock while it’s still down.

Recurring income

As an e-commerce firm specializing in pet products, Chewy has been able to create a strong recurring business model that saw 78.4% of its sales last quarter come from Autoship customers. These customers are also Chewy’s most loyal and fastest growing. While global sales in the second quarter were up just 2.6%, Autoship sales were up 5.8%.

The company has about 20 million active customers, and sales per active customer also grew, rising 6.2% last quarter. Meanwhile, the company said that last year, about 85 percent of its sales came from non-discretionary items such as pet food and pet health products.

Pet owners continue to spend more on their pets, but a decline in pet household formation due to an increase in pet adoptions during the peak of the pandemic has slightly slowed income growth this quarter. year. However, pet ownership has increased over the past three decades, and Chewy expects 2025 to see more of a return to normal trends.

Chewy’s Autoship model offers a lot of predictability and visibility into future revenue, which investors really appreciate. Both subscription models and non-discretionary sales tend to fetch higher multiples, and Chewy offers investors both.

Image source: Getty Images.

Margin improvement

Chewy’s continued margin improvement will be one of the big drivers for its future, leading to earnings growth far outstripping sales growth. This should come from both gross margin improvement and operating expense leverage.

In terms of gross margin, Chewy has a few things going for it. Removing a page from AmazonIn his playbook, the company started using sponsored ads on its website. With gross margins of around 70%, this business has much higher margins than the overall Chewy business.

In addition, the company has made inroads into the pet pharmacy segment, selling pet medications and offering other health services. This is a much higher margin business than retail, up to 1,000 basis points higher than retail. With only about 20% of its customers using Chewy’s pharmacy services, this is a potentially large revenue and margin generator.

The company also entered private label brands, which at scale have gross margins 700 basis points higher than national brands. While the private label posted single-digit sales last year, the company believes it can reach 15 percent or more in the long term.

On the other hand, Chewy is keeping its operating expenses under control and generating cost and efficiency improvements. The company has a very high fixed cost infrastructure, so as sales increase, it also sees good operating leverage.

The company’s efforts in these areas could be seen in the results of the second quarter. Its Q2 gross margins rose 120 basis points to 29.5% in the quarter. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margins, meanwhile, rose from 3.2% to 5.1%.

The effect of these margin improvements could be seen in the increase in Adjusted EBITDA from $88 million to $145 million. That’s a 65% increase on just a 2.6% increase in sales.

Attractive valuation

From a valuation perspective, Chewy stock currently trades at a forward price-to-earnings (P/E) ratio of about 26, based on analysts’ next-year estimates. While that may not seem cheap, given the projected sales growth of 4% to 6% this year, there are a few things to keep in mind.

The first is that Chewy is expanding its margins and showing good operating leverage, so its profitability metrics like earnings and EBITDA are growing much faster than sales. Meanwhile, companies that tend to have recurring revenue streams or sell non-discretionary items tend to be worth higher valuations given their resilience and predictability.

On this front, the company’s valuation is below that of a Walmart and even above Supplying the tractortwo retailers that primarily sell everyday products. But Chewy is also growing its earnings faster than those two retailers.

With that in mind, the stock appears to be trading at an attractive valuation and has more upside ahead as sales and margins continue to improve.