When a dog wags its tail slowly, it's still postive, just a bit less enthusiastic. That's how this quarter felt... good, but not quite as exciting as we had been seeing from CHWY. When we held our Pet Industry Black Book in April (Replay: CLICK HERE), we moved CHWY to the bottom of our Best Idea Long list noting the risk from near term slowdown. That’s what we got here and what the market had been signaling for the last few months. We’re keeping CHWY where it is on our Best Idea long list. Are we about to see a fundamental rip in the model? No. Are you getting a good price today to buy a category killer with a long term global growth story and accelerating profitability? Yes. We struggle to find a retailer as likely to dominate a category as CHWY will in online Pet Care, and that category is one of the best in retail.
CHWY delivered a fine quarter, with EBITDA well ahead of expectations though in the context of a slowdown in revenue and customer adds below expectations. 1Q revenue grew a strong 31.7%, but that’s after 2020 delivered 47% growth. Management seems to be crediting lower customer add levels to the typical churn rate on such a big 1Q20 cohort, citing gross adds as still around the 2019 levels it had expected. Even in the context of the comparison, we’d expected CHWY to see higher adds (ie an acceleration in the 2 year stack), but we didn’t get that. At the same time management is citing strong wallet share trends and lots of share to still be won, though the comparisons and out of stocks meant lower spend per average customer in the quarter as well. So CHWY had to deliver on margins, which it did. Gross margin was up 420bps with half being credited to “structural business improvements”, the other half to lower freight and logistics costs lapping covid disruptions last year. Adjusted EBITDA margin improved 340bps despite the need for elevated labor expense and dealing with labor shortages.
CHWY has been a top long of ours for about 15 months, and perhaps our core disappointment with CHWY over that time frame is the lack of detail provided around the International expansion opportunity. We’ve simply gotten the “more than 1 year less than 5 years” answer repeatedly. We understand management is being patient, and that the last year or so has been an incredibly challenging time to try to invest in and build international businesses, but by now we would have expected at least some communication of a timeline or vision for the international launch. We think that the new market opportunity is a key part of the long term growth thesis for CHWY. This quarter the company again dismissed the chance of the sell side adding international to their models over any duration. If the company doesn’t deliver some material improvement in net adds over the coming couple quarters, the investor pressure to start the international push will really start to intensify.
After this quarter we’re tempering our near term customer additions but increasing spend per customer in 2H some given lower new customers means we’ll have a higher portion of ‘seasoned’ customers that spend more and more each year. We’re also upping our margin assumptions after the company delivered these impressive 1Q margin and cashflow results. We’re coming out well ahead of the consensus driven by growth international starting in late 2022 and further expansion into pet health and services.
