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September 01, 2020 1:32pm
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Chewy, Inc. Results Provide Ample Reason to Buy the Stock

CHEWY logo visible on display screen

Chewy, Inc. (NYSE: CHWY) defied expectations and produced a solid Q1 that suggests momentum, continued strength, and rapidly improving shareholder value in the year's second half. Although growth has slowed, performance is better than expected, compounded by significant margin improvement. The margin improvement is the most notable detail, as it led the board to authorize a share repurchase program. 

Chewy, Inc.’s share repurchase program is worth $500 million without expiration. The sum is worth about 6% of the market cap and will help support the stock over time, but the amount of support is questionable. Share-based compensation increased Chewy’s share count by 1.4% on average in Q1 and is expected to continue. The best investors might expect is for repurchases to offset share-based compensation initially and grow over time. Regardless, the authorization affirms the business's health and cash flow, both improving. 

Chewy.com Cements Leadership Position in the Pet Market

Chewy.com had a solid quarter, growing revenue by 3.1%, outpacing the consensus estimate despite the expected slowdown. The slowdown is due to market normalization following the COVID-19 pandemic; the takeaway is that normalized markets are growing at a mid-single-digit rate, and Chewy is gaining market share

Revenue growth is driven by a 9.6% increase in revenue per active member, offset by a 2.1% decline in customers. The critical details include the 6.4% increase in Autoship sales and the 240 basis point improvement in top-line contribution. Autoship is important because it is a recurring revenue that can be counted on for cash flow and 77.6% of the net. 

Margin news is favorable. The company widened its margin in all comparisons by at least 100 basis points. Gross margin improved by 130 bps, adjusted EBITDA margin by 170 bps, and net income margin by 150 bps. The net result is that GAAP earnings grew by 200% and adjusted EPS by 55% to top $0.31 per share, outpacing consensus by $0.11. 

Chewy.com doesn’t give guidance but shows momentum with growth in transaction size and auto-ship that should continue in FQ2 and the second half. This should lead the analysts to raise their targets because they have set the bar low. The question is how much lift the news will provide, which could be considerable. The board’s decision to back shares signals a shift for the business that puts Chewy on track to drive long-term shareholder value.

Analysts Lower Bar for Chewy Ahead of Earnings

Analysts lowered the bar for Chewy stock ahead of earnings but set it far too low. The most recent revisions have the stock trading at the low end of the range, now the market floor. Assuming the trend in downward revisions ends, the market should have no trouble maintaining the floor and may even enter a reversal. The consensus target is down nearly 40% from last year but still offers a solid 25% upside, and analysts may start to lift their targets. In that scenario, this market could move above critical resistance at $25 and reach the $40 level. 

Market dynamics favor a complete reversal for this stock. There is some risk of short-sellers capping gains at $25, but the risk is small. The 5% short interest is slightly elevated but not a sign of bearish conviction. Conversely, the institutions have been buying the stock on balance for four consecutive quarters and have ownership up to nearly 95%. That is a sign of bullish conviction.

The technical outlook is strong. The market opened with a large gap higher then continued to increase on high volume. In this scenario, the market could reach $22.50 within days and retest $25 within the week. 

Chewy stock chart

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Photography by Christophe Tomatis
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