Macro-Level Issues Are Keeping Chewy in the Doghouse

From the early 2000s, Pets.com was the primary poster for stocks that rose in hype and then fizzled and disappeared as part of the dot-com crash. Clearly, consumers were not ready to embrace e-commerce for pet supply.

Whereas Pets.com may have been ahead of its time, an online retailer rubbery (NYSE: you) — which spun off PetSmart into a public entity in 2020 — has had some success, thanks in part to a pandemic-driven shift toward more e-commerce use.

Image source: Getty Images.

While Chewy’s stock doesn’t follow the same path that Pets.com did, there has been an unmistakable boom and collapse in the stock price since its IPO in June 2019. However, a stock price rebound could be in the cards since Chewy’s remarkable revenue growth – And some “strict” determination by management to expand the company’s business model may only tend to a profitable financial profile.

Chewy’s earnings growth remains strong

To determine if Chewy is a good fit as a value game, potential investors must weigh the company’s positives against a negative one.

On the positive side, Chewy’s balance sheet appears to be improving as the company’s cash and cash equivalents rise during the first three quarters of the year (ending October 31). Moreover, in the same time frame, Chewy’s total assets increased from $1.7 million to $2.2 million – but then, the company’s total liabilities almost completely reversed these numbers.

However, the star attraction for bulls is Chewy’s distinct trajectory. The company’s third-quarter 2021 net sales of $2.21 billion showed a 24.1% year-over-year improvement, while the quarterly gross margin of 26.4% indicated an annual expansion of 90 basis points — not too bad.

The big disadvantage of chewing

But while Chewy is seeing sales growth and a strong position in its niche market, the online retailer remains unprofitable on a bottom line. Chewy’s net loss of $32.2 million in the third quarter does not represent a significant improvement from a net loss of $32.8 million in the third quarter of 2020. On the other hand, the company’s net loss of $10.2 million for the first three quarters of 2021 combined shows tremendous progress compared to net loss of $113.5 million in the first three quarters of 2020.

The lack of net profitability continues to bother some investors. CEO Sumit Singh blamed Chewy’s negative third-quarter earnings results on ongoing supply chain disruptions, labor shortages and rising inflation. Chewy included $93.3 million in expenses in the “inventories” category for the first three quarters combined, which certainly reflects an inflationary economy.

Chewy goes beyond toys and candy

One way to offset the increased cost of inventory is to generate income from sources that are much less affected by things like availability of supplies, shipping, sorting, or labor costs. This is partly why Chewy recently announced a partnership with a pet medical insurance provider Tropanion 09.30 NASDAQ: TRUP. Through this partnership, Chewy will be able to offer its online customers (or more accurately, their pets) preventive health care plans and comprehensive insurance plans for accidents, diseases and chronic conditions. In this care model, Chewy will use Trupanion to pay vets directly, thus (hopefully) reducing out-of-pocket expenses for pet parents.

At the very least, the Trupanion collaboration should diversify Chewy’s business model. However, it remains to be seen if Chewy’s customer base of 20 million pet parents will choose to subscribe to more than one pet food and product.

Are investors barking the wrong tree?

Investors looking for a business that can circumvent macro-level problems such as inflation and supply chain bottlenecks likely won’t find a solution in Chewy.

For now at least, food, games, and candy are still Chewy’s bread and butter. But diversifying into medical care for pets could help the company move away from the global problems that seem to haunt many product suppliers today.

Chewy is still growing big in sales, and the company’s profit loss is at least under control even if it doesn’t shrink at a pace every investor would like. This is still a relatively young company focused more on growth than profits at the moment, so patience is required. In the final analysis, Chewy investors must remain risk-sensitive in e-commerce to the core.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of the Motley Fool Premium Consulting Service. We are diverse! Asking about an investment thesis — even if it’s our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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