Chewy, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Chewy is an online retailer of pet food and products with a subscription model for recurring purchases and a robust infrastructure for delivery.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Chewy’s moat can be classified as a narrow moat. While the company has several strengths, like strong brand loyalty and supply chain efficiency, the company’s advantages do not appear powerful or difficult enough to be replicated for extended period of time.

Let’s delve into the details of Chewy:

Business Overview:

Chewy, Inc. primarily operates as an online retailer for pet products and medications. They offer a wide selection of pet food, treats, toys, and other supplies, along with a growing pet health business.

A significant part of Chewy’s business model is its Autoship program which drives repeat business from subscriptions for pet food. This is a major source of revenue, contributing to a fairly predictable income stream.

  • Revenue Distribution: Most of Chewy’s revenues come from online sales through their website and mobile app. They also derive some revenues from their healthcare business.

  • Industry Trends: The pet care industry is currently seeing strong growth, with increased spending on premium foods, healthcare, and pet services. The COVID-19 pandemic has shifted much of the buying to online, which has boosted the demand for e-commerce pet food companies. However, competition among pet food companies is intense.

  • Margins: Chewy has experienced fluctuations in its operating margins. While gross margins have improved, operating expenses, particularly in advertising and marketing, have remained substantial. This indicates the company is still spending a lot to acquire and retain customers and expand its brand.

  • Competitive Landscape: The pet products and medication industry is highly competitive. The main players include brick-and-mortar retailers such as PetSmart and Petco, online retailers such as Amazon and Chewy, and a plethora of other smaller pet product companies and companies providing medications to pets.

  • What Makes Chewy Different: Chewy differentiates itself with a wide selection of high quality products and a strong focus on customer service. The Autoship subscription program builds a predictable revenue stream, a high level of repeat sales, and loyal customers. They also use a powerful network infrastructure to quickly and accurately process orders with quick deliveries.

Financials (Recent Data):

Chewy’s Q3 2023 results (13 weeks ended October 29, 2023) showed net sales increased by 8.3% year over year to $2.73B. Key Points:

  • Revenue Growth: While the 8.3% growth rate was decent, it shows a slowdown from previous periods. This slowdown is due to a weaker consumer spending environment. However, the subscription business continues to be an anchor of growth.
  • Margins: Gross margin increased 1.3% to 28.4%. They said that this has come from disciplined pricing and supply chain efficiencies. However, selling, general, and administrative (SG&A) expenses were down about a percentage of net sales, which shows a focus on profitability.
  • Net Loss: Chewy reported a net loss of $41.5 million, improved from last year’s losses. This is a good sign for its efforts to move towards profitability. Adjusted EBITDA was a healthy $66.5 million, showing improvements in operational profitability.
  • Customer Growth: The company reported total active customers decreased to 20 million from 20.4 million year-over-year. However, autoship sales still represent 75% of total net sales. This highlights the strength of the subscription model in generating repeat revenues.
  • Guidance: Chewy’s revised 2023 full-year guidance of around 10.6 billion dollars in net sales suggests that expectations for growth are a bit moderate. The adjusted EBITDA margin forecast for full year is now 1.6%, which implies expectations for profitability are stable or increasing.
  • Financial Position: As per the latest reports, Chewy has over $700 million in cash and investments, which is more than $100 million higher than at the same period a year ago. The overall liquidity of the company seems sound.
  • Capital Expenditures: Chewy’s capital expenditures appear to be at a relatively moderate rate, meaning that the company is not aggressively spending on physical assets. This aligns with their business model that doesn’t need a huge real estate footprint.

Recent Concerns/Controversies/Problems & Management Response:

  1. Slower Growth and Reduced Spending: The company has seen a slowdown in active customer growth and a reduction in discretionary spending by consumers, especially on big ticket items, which has slightly lowered management’s outlook for growth. Management Response: They claim to focus on driving value from existing customers, rather than aggressively acquiring new ones. They are also focusing on higher margin sales and subscription growth.
  2. Competition and Rising Prices: The competition within the industry is intense, with both offline and online retailers competing for pet owner’s wallets. At the same time, there is inflation, which puts a pressure on input costs and the margins. Management Response: Management said to be optimizing its supply chain, improving margins, and providing high quality products for their customers. They are not focusing on the short-term, rather, long-term.
  3. Gross Margin Volatility: Gross margins have shown good growth lately, but that is often offset by higher operating and marketing expenses, which can make profitability appear cyclical and can make the business appear inconsistent. Management Response: Management intends to improve efficiency, increase margins, and decrease operating and marketing expenses in future to make profitability sustainable.
  4. The need to improve customer retention: The company had fewer active customers this quarter than the previous year, showing that it needs to concentrate more on customer retention, because acquiring new customers is very costly. Management Response: Management has stated that they are focusing more on long-term value through Autoship subscriptions, which are much more sticky than one-time purchases.
  5. Lack of consistent EPS: The business has always been inconsistent with profits. Although the company has shown increasing revenue and strong brand value, it has struggled to convert into a consistent profit stream. Management Response: Management has implied that as their strategies take more shape, their earnings will normalize over time and become better in the future.

Moat Assessment (3/5):

  • Narrow Moat: Chewy possesses a narrow economic moat due to:
    • Brand Loyalty: Chewy has been successful in building strong brand loyalty, partly because of its high customer service ratings and a strong online community.
    • Autoship Subscriptions: Their autoship program is a strong moat because most of its revenues come from it, and it is a hard and time consuming task to transition to another one.
    • Network Infrastructure: They have an impressive, well-functioning distribution network that is hard to replicate, which gives them a good cost advantage in logistics and delivery.
  • Weaknesses:
    • Intense Competition: Despite those strengths, there is no shortage of options for customers to buy pet food and medicines. In other words, the moat is leaky.
    • Switching Costs In general, switching costs are not high in pet retail, meaning that customers can easily switch to a cheaper alternative without any difficulty.
  • Technological Disruption: The internet may be very reliable, but its very nature and the fact that it is online makes it susceptible to quick disruptions with better technological products and service, or even a change in the consumer’s mind.
  • Pricing Pressure: They operate in a relatively price sensitive market. Competition often results in pricing wars, making profits less secure and more volatile.

Understandability Assessment (2/5):

  • Complex Logistics: The company is not hard to understand, it is essentially a pet supplies store, but the process behind the scenes, from manufacturing, supply chain and logistics, to selling and delivering, is very complex.
  • Accounting Nuances: Its financial statements are complex due to its many acquisitions, investments, and unique strategies. This can make reading them more difficult.
  • High Competition: Given the many different companies competing, understanding their strategy and performance is not easy.

Balance Sheet Health Assessment (4/5):

  • Solid Cash Position: Chewy has a decent liquidity and a good amount of cash on hand for its size, and it is still growing.
  • Manageable debt: Overall, they do not have that much debt for its operations and are not over-leveraged.
  • Improving Profitability: The company is showing improvement in profitability, although it has still some way to go.

The Bottom Line:

Chewy is a strong player in a growing industry, but it is important to see that the business still needs to prove that its moat is robust enough to fend off competitors for the long term and maintain a consistent profitable business model.