Pet supplies retailer Chewy (NYSE: CHWY) went public last month, raising over $1 billion in its debut, as investors greeted the offering like a dog welcoming home its owner after an extended separation.
While there are some good arguments that favor the excitement around the issue, Chewy faces some challenges, too, and as it's scheduled to make its first earnings report as a public company on Thursday, July 18, let's look at what investors might expect.
Investors may not be licking their chops over this recent IPO. Image source: Getty Images.
Profiting off the fur-baby trend
Industry trends are heading in the right direction for Chewy. The American Pet Products Association forecasts that owners will spend almost $75.4 billion on their pets this year, up 3.9% from 2018, and over two-thirds of it will be on food and vet care.
Here's a breakdown of where pet owners spend their money.
% of Total
Live animal purchases
Data source: American Pet Products Association.
Chewy generated $3.5 billion in sales last year across all of those categories (except live animals), up 68% from the year before, obviously benefiting from the willingness of pet owners -- or pet parents as everyone likes to call them -- to spend in all kinds of economic conditions. A household may forego buying steak during a downturn, but Fido is still going to get his food.
And the premiumization trend that's gripped other consumer goods is still going strong in pet products. Data from Packaged Facts shows approximately 75% of pet product buyers last year were willing to pay more for healthier pet food products, up from 67% in 2015. It's also increasingly purchased online, with e-commerce sales accounting for 14% of the total food and supplies market in 2017, significantly higher than the 4% recorded two years prior. More importantly for Chewy, it is expected to hit 25% by 2022.
Not all sales are equal
Chewy expects its own sales to rise 45% in the first quarter, hitting $1.1 billion, as autoship subscription sales surge 55% to almost $744 million. Though as my colleague Timothy Green recently highlighted, those numbers mean a lot less than what they seem.
Autoship sales are those where customers agree to have products shipped to their home on a regular basis. Although they account for around 75% of total revenue, they're low-quality sales because Chewy doesn't provide information around the data. A customer could sign up for autoship to score a discount on an order, and then cancel it the subscription the next day. Chewy doesn't let you know what its churn rate is.
Who let the dogs out?
The online pet products company has another problem too in that while it might be the premier online retailer for pet products, the industry is highly fragmented and some much better financed rivals also target the space.
Cereal maker General Mills (NYSE: GIS), for example, bought premium pet food company Blue Buffalo last year and has since fully integrated it into its operations. The transition has been successful with average year-to-date retail sales rising by high single-digit percentage rates in its fiscal four quarter while it continues to gain market share. General Mills also said e-commerce sales jumped 21% in the fiscal year.
Amazon.com has also entered the pet products market, launching Wag, a pet food and pet supplies brand, and Freshpet is beginning to turn itself around, and its shares are up 77% from recent lows as sales improve.
For all of Chewy's sales growth, it remains a money-losing operation, reporting losses of $268 million last year. The preliminary data released ahead of its IPO has it expecting losses to continue in the first quarter of $29.6 million, though they'll be much narrower than the $59.8 million loss it recorded a year ago.
Chew on this
Chewy remains controlled by its former parent PetSmart, which owns 278.4 million shares, representing 70% of Chewy's total outstanding shares and 77% of the voting power. That's key because PetSmart's creditors charge that without Chewy, the bricks-and-mortar retailer is insolvent, and charged the spinoff was the only way it can stay afloat.
As it will be the primary owner of the business with complete say in how Chewy operates, its decisions might not always be in the best interest of outside shareholders.
Chewy's first quarter as a public company should show a growing business, but there is a lot going on behind the kennel that ought to give investors significant pause to stay away regardless of what the numbers show.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.