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- By Dilantha De Silva
Chewy Inc. (NYSE:CHWY) serves a niche market in the pet products industry. The company is a pure-play online retail and wholesale consumer discretionary company focused on selling pet care products, including food, treats, health care and medications.
The release of fourth-quarter earnings on March 30 led to a sharp 10% increase in the share price as a result better-than-expected results. It reported revenue of $2.04 billion, a 51% increase year over year, on earnings of 5 cents per share.
Many Wall Street analysts followed up this earnings surprise with positive comments regarding the company's outlook. Although the stock has already appreciated 130% in the last 12 months, Chewy shares might still be attractive for investors with above-average risk tolerance.
Fourth-quarter earnings recap
The earnings beat might not have been a surprise to investors who were closely following the company. Chewy is among the many online retail businesses that became winners of the mobility restrictions imposed by the government during the Covid-19 lockdown. E-commerce sales in the U.S. grew 32.4% during the fourth quarter in response to the public health emergency measures implemented.
According to data collected by National Geographic, the demand for adopting or fostering pets has increased sharply over the last 12 months as people have used raising pets as a strategy to fight pandemic-related stress. Their research suggests having a pet provides emotional support, lowers blood pressure and improves mental health. According to Morgan Stanley (NYSE:MS) analysts, the number of households that owned a pet increased 5.6% in 2020, and this favorable macroeconomic development aided Chewy's growth.
At present, the company has a customer base of 19.2 million after adding 1.4 million active customers in the fourth quarter. The customer retention ratio improved by 240 basis points and net sales per active customer rose 3% to $372. The company reported net sales of $2.04 billion for the fourth quarter, with 40% faster growth in hard goods sales and a 21% increase in proprietary brand penetration. The latter will play a key role in helping Chewy expand its operating margins in the future, and the company remains focused on improving the penetration from this segment further.
Wall Street analysts are getting behind Chewy
The surge in demand for pet products resulted in an unexpected swing in Chewy's profits, helping the company beat Wall Street's sales estimate of $1.96 billion. The solid earnings led to several upward revisions to the target price assigned for Chewy shares by top experts covering this business sector.
In a research note to clients, Morgan Stanley analyst Lauren Schenk wrote:
"CHWY looks poised to deliver another solid year of top-line growth, with 4Q, 1Q, and '21 guidance all slightly ahead of expectations. We remain bullish the pet category and CHWY's market share gains but stay EW on valuation."
The analyst raised the price target to $83, which implies the stock is fairly valued in the market today.
Jefferies analyst Stephanie Wissink wrote, "the profitability track for the online pet supplies retailer is two years ahead of the IPO model" and increased her target price to $105, suggesting the stock has an upside potential of 27% from the closing market price of $82.71 on April 1.
Bank of America (NYSE:BAC) has a target price of $133 for Chewy, which implies significant undervaluation in the market at present. Analyst Nat Schindler recently wrote:
"We see plenty of positive signs for longer-term growth trends, with the creation of new pet profiles up 35% y/y in 2020 for puppies and kittens signaling higher staple consumption of food, hard goods, and healthcare services over time. The new cohorts are also showing higher repeat order rates, and higher average value per order (on repeats). Pharmacy operations topped the $500M revenue goal set last quarter and we view the high-margin healthcare vertical as one of the growth drivers in 2021."
Considering this positive stance of top analysts, it does not come as a surprise that the consensus estimate for Chewy's earnings has been revised substantially higher over the last 60 days, which is a very promising sign as this suggests the company is on track to surprise analysts once again when the next earnings results are due.
The outlook for the company
Chewy offers a broad range of pet-related products and services. The company is laser-focused on expanding its product range even further to capture market share. In 2020, the company benefitted from the investment in inventory to meet the increasing demand and it intends to follow the same strategy to protect the supply chain from possible industry disruptions.
The company will continue to make bold investments to improve inventory turnover, productivity and consumer engagement. Chewy plans to invest approximately $60 million to hire new staff to improve the efficiency of the business process, which seems to be the right strategy because timely delivery of e-commerce sales is a critical factor that would have a major impact on the long-term earnings power of the company. During the fourth-quarter earnings call, management confirmed that customer servicing will remain a key focus in the coming years.
Chewy is investing in artificial intelligence-powered solutions as well, and the idea is to achieve cost efficiencies in the next five years by automating the business process. This is also a very positive development as the deployment of 5G is expected to significantly improve the use cases of artificial intelligence.
The company recently launched Connect with a Vet, a telehealth service designed to help pet owners easily connect with a qualified veterinarian to get immediate health advice for pets. This revolutionary service will further establish Chewy's presence as a one-stop-shop for everything related to pets and their health care, which could eventually lead to strong competitive advantages resulting from customer stickiness.
The e-commerce industry soared to new highs in 2020 as a result of the global lockdown, and the trend is set to continue in 2021 as well. Chewy is well-positioned in the growing online retail industry with its subscription services, hard goods and proprietary brands. According to the American Pet Products Association, Americans spent $99 billion on pet and pet-related products and services in 2020, which is the highest-ever reported figure in any calendar year. This new-found interest in pets is likely to help Chewy report double-digit revenue growth in the next couple of years.
The company recently confirmed that expansion beyond the United States is on the cards, which could be a catalyst for growth. For now, Chewy is focused on margin expansion. The strategy is to earn sustainable profits before expanding internationally, which indicates management is long-term-oriented. Although value investors might find Chewy richly valued in the market, growth investors are likely to be attracted to the company because of the sizeable opportunities available in the pet care industry.
Disclosure: The author does not own any shares mentioned.
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This article first appeared on GuruFocus.