Chewy Stock (NYSE:CHWY): The Next Phase of Its Growth Begins

May 07, 2023

Chewy, Inc. (NYSE:CHWY), one of the leading online retailers of pet products in the U.S., is ready for the next phase of its growth story, where the company will focus on international markets. CHWY reported better-than-expected earnings for the first quarter, triggering a 21.6% rally in its stock price on June 1. The firm enjoys a long runway for growth both in the domestic market and internationally, making it an attractive bet for growth investors looking for fairly-priced companies.

I am bullish on Chewy's long-term prospects, but caution is needed today, with macroeconomic trends pointing toward a challenging few quarters before growth resumes.

During the first-quarter earnings call, Chewy CEO Sumit Singh revealed a plan to expand Chewy's business into Canada by the third quarter of this year. The company will initially launch its services in Toronto, which is the largest metropolitan area in the country. Chewy, for many years, has explored options to expand internationally, and its entry into Canada will mark the beginning of a new growth phase where the company focuses on the lucrative international market.

According to Euromonitor International, Canada's pet food market is expected to grow at a compounded annual growth rate of around 5% through 2027, similar to the United States. Although the U.S. will still be the biggest market for pet food products by 2027, many emerging nations are expected to grow at a much faster clip. For instance, China's pet food market is expected to grow at a CAGR of over 10% through 2027, while Indonesia and Taiwan are expected to register growth of 20% and 7%, respectively.

With international markets expected to grow quickly in the next five years, it makes sense for Chewy to aggressively invest in these markets to grab market share in growing regions. The planned expansion into Canada will create a strong platform for Chewy to consider other high-growth regions as well. The success of Chewy in global markets will determine the sustainability of earnings growth in the future.

International markets represent the biggest growth opportunity for Chewy today, but there is a long runway for growth in the U.S. as well. The continuation of the pet humanization trend that was triggered by the pandemic has led to a meaningful rise in expenditure on pets. From $90.5 billion in 2018, total pet industry expenditures in the U.S. jumped to $136.8 billion in 2022. According to data from the American Pet Products Association, Americans spent a total of $58.1 billion on pet food last year and a staggering $67.4 billion on vet care, OTC medicine, and supplies.

The massive expenditure incurred on pet healthcare products opens up new doors for Chewy to grow in the future as the company aggressively expands into this category. With a product and services suite catering to different needs at every stage of the pet care lifecycle, Chewy is well-positioned to benefit from the increased spending on pets through online channels.

In the first quarter, Chewy's active customer base declined 1% year-over-year to 20.4 million. Although this is not an encouraging sign, net sales per active customer grew 15% to $512, eclipsing the $500 mark for the first time. This stellar growth was driven by the continued success of the Autoship subscription (Chewy's subscription plan offering). Autoship customer sales accounted for more than 74% of total sales in Q1, which is a testament to how Chewy is driving sales higher through the subscription program.

Increased customer spending in the first quarter is an early sign that Chewy is well-positioned to survive an economic downturn if it were to occur later this year. Although discretionary spending on pets will decline during challenging economic conditions, Chewy stands to benefit from its focus on essential product sales in categories such as pet grooming, pet foods, and pet healthcare.

Chewy's adjusted EBITDA margin improved by 150 basis points to 4% in the first quarter, enabling the company to generate $119.3 million in free cash flow. Going forward, margins may come under pressure as the company will have to incur additional costs to execute its international expansion plans. Temporary pressures on profit margins, however, should be overlooked as long as these setbacks create an opportunity for the company to thrive in the long run.

Although Chewy's active customer base contracted in Q1, some analysts are confident about the company's ability to attract and retain customers in the coming quarters. Raymond James analyst Rick Patel assigned Chewy stock a price target of $36 last month, citing the potential for a positive inflection in active customer trends in the second half of this year. Based on the ratings of 23 Wall Street analysts, CHWY earns a Moderate Buy consensus rating, and the average Chewy stock price target is $44.05, implying upside potential of 19.9%.

Chewy's planned international expansion seems a timely move to make the most of the growth opportunities available in global markets that are expected to grow at a stellar pace. The pet humanization trends in the U.S. will help the company's earnings growth as well. As a diversified pet care platform, Chewy should continue to grow for many years to come.

Disclosure