Profit ratio

Why Chewy Stock Could Be a Buy in the Coming Weeks

Online pet store Soft (CHWY -2.00%) flourished at the start of the pandemic as more consumer spending shifted online and people brought home more pets. These trends have boosted sales while attracting millions of new customers. Luckily for Chewy, those benefits aren’t reversing as economies reopen.

However, Chewy is dealing with the secondary consequences of the coronavirus pandemic. Supply chain disruptions limit production as consumer demand increases. This causes widespread inflation and makes it difficult for Chewy to meet strong customer orders.

Chewy reports its first quarter results on June 1. The temporary headwinds could cause it to report disappointing numbers, driving down its stock price. It will be a great buying opportunity for long-term investors if that happens.

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Chewy benefits from increased number of pet owners

In the two years since the outbreak, Chewy has increased sales by $4 billion, or 83%. Consumers have brought home millions of new pets to make time at home bearable. The good news for shareholders is that pets are a long-term commitment. As they get older, they eat more, destroy more toys, and force owners to maintain spending. Therefore, the boom Chewy has experienced during the pandemic could have lasting benefits.

In fact, during the same period, Chewy added 7.2 million new customers, a gain of 54%. One feature Chewy customers love is the autoship option. People select the items they want to buy and how often they want to receive them (once a month, once a week, etc.). In its last quarter, 70.2% of sales were made through the autoship program. For shoppers, it removes a task from their to-do list and ensures they never forget Rover’s food.

For Chewy, this reduces business risk because it lets you know in advance what buyers are going to buy. Chewy won’t buy inventory he doesn’t expect to sell, reducing the chances of getting stuck with unwanted products that he has to cut prices to get rid of.

Chart of CHWY's operating margin (annual)

CHWY operating margin (annual) given by Y-Charts

Overall, Chewy has made excellent progress in capturing a meaningful share of the $120 billion pet market. Sales grew from $2.1 billion to $8.9 billion from 2018 to 2022. Simultaneously, Chewy reduced operating losses and demonstrated economies of scale.

Further weakness in stocks could be a buying opportunity

This is all good news, but Chewy faces strong near-term headwinds. Supply chain disruptions cause many items at Chewy to run out of stock, causing it to miss sales. Meanwhile, he has to pay higher prices for labor, inventory, transportation, etc. Inflationary pressure caused its gross profit margin to decline year over year in its last quarter. Cost increases could worsen in the short term, as fuel prices have risen since the Russian invasion of Ukraine.

Table of PS CHWY ratios

PS CHWY report given by Y-Charts

These forces could cause Chewy to report worse-than-expected first-quarter sales and earnings on June 1. Chewy’s stock is already down 80% from its peak. It would not be surprising if it drops even more if the headwinds are indeed greater than expected. If this scenario plays out, it could be a buying opportunity for long-term investors. Chewy is already trading at its lowest price-to-sales ratio in years. A drop in stock prices after the first quarter results could be an even bigger boon.

The short term will remain difficult for Chewy as he grapples with the aforementioned headwinds. However, its longer-term prospects are strong as it grows revenue, increases margins and adds millions of customers who spend more with Chewy every year.