How Calculated Investments And Customer Loyalty Propel Growth In Pet Care Industry

Key Takeaways

• Chewy's efficient scaling and business model promise enhanced margins through leveraging high-margin ventures and fixed cost benefits, positively affecting net margins.
  
• Strategic investments backed by strong free cash flow and a solid balance sheet support long-term growth and may positively impact EPS.
  
• Chewy's financial health is threatened by volatile customer loyalty, high competition, and the challenges of expanding services like Vet Care, impacting profitability.

Catalysts

Engages in the pure play e-commerce business in the United States.

• Chewy's rapid scaling operations and efficient business model are expected to deliver strong margin expansion by leveraging high-margin businesses and fixed cost leverage, impacting net margins positively.
  
• The autoship program, representing 78% of net sales, and growth in net sales per active customer (NSPAC) indicate a strong customer loyalty and increased share of wallet that are likely to continue driving revenue growth.
  
• Expansion of Chewy Vet Care clinics and the positive reception from both customers and the vet community suggest new customer acquisition and enhanced customer engagement, potentially increasing both revenue and NSPAC.
  
• Sponsored ads business ramping up to meet long-term targets and the implementation of a new 1P technology stack are expected to grow net sales, improve supplier experience, and reduce service costs.
  
• Strong free cash flow generation and a robust balance sheet enable strategic investments in long-term growth areas and share repurchase transactions, which may favorably influence earnings per share (EPS).

Assumptions

• Analysts are assuming Chewy's revenue will grow by 6.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 3.2% today to 2.5% in 3 years time.
• Analysts expect earnings to reach $350.2 million (and earnings per share of $0.84) by about November 2027, down from $362.5 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $439.5 million in earnings, and the most bearish expecting $195 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 46.9x on those 2027 earnings, up from 38.0x today. This future PE is greater than the current PE for the US Specialty Retail industry at 16.0x.
• Analysts expect the number of shares outstanding to decline by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.74%, as per the Simply Wall St company report.

Risks

• The reliance on a growing yet potentially volatile Autoship customer base, which while currently beneficial, carries a risk if consumer preferences shift or competitive offerings lure away these loyal customers, potentially impacting Chewy's revenue growth and net margins.
  
• There's a risk associated with the execution and continued rollout of Chewy Vet Care clinics, including the ability to attract and retain qualified veterinarians and to scale these operations without impacting profitability due to high startup and operational costs, affecting net margins.
  
• Chewy faces intense competition from both online and brick-and-mortar retailers in the pet supply market, which could pressure the company to increase promotional activities or lower prices, potentially eroding profit margins.
  
• The success of Chewy's sponsored ads business is contingent upon maintaining high advertiser demand and managing inventory effectively. A failure to do so could result in lower-than-expected revenue contribution from this segment, impacting overall profitability.
  
• The company operates in a dynamic and highly competitive market where consumer preferences can shift rapidly, including trends related to pet ownership and spending on pet care. A significant downturn in the pet market or a failure to anticipate and react to these trends could adversely affect Chewy's revenue growth and earnings.

Valuation

• The analysts have a consensus price target of $32.47 for Chewy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $40.0, and the most bearish reporting a price target of just $24.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $13.8 billion, earnings will come to $350.2 million, and it would be trading on a PE ratio of 46.9x, assuming you use a discount rate of 6.7%.
• Given the current share price of $32.94, the analyst's price target of $32.47 is 1.5% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.