Our Take On the Quarter
Another impressive quarter from Best Idea Long Chewy, as the company put up another positive EBITDA quarter while the Street was modeling negative cash flow. Revenue clocked in at +47% -- spot on with a positive covid-impacted 1Q rate. CHWY added a staggering 1.6mm active customers – again, spot-on with the 1Q rate when the covid benefit was at its peak. We were looking for 1mm net adds, which in itself is an impressive level, and CHWY smoked our forecast. For 1H net adds are 3.12mm, which is super impressive given that it added 2.9mm in all of last year. Sales per active customer were up 8.9%, which is notable given the fact that in year 1 new customers have the lowest spend, and it grows dramatically in years 2 and 3. So there’s usually a trade-off between sales/customer and customer adds, but not so this year…and we’ll take an elevated customer count over the former any day of the week given the stickiness of the customer base once a customer is added to the mix. The gross margin pressures that CHWY had in 1Q passed, and GM came in at 25.2% vs expectations for 24.3%. Guidance was once again ‘light’, if you want to call it that, which is the only real negative. But as transparent and upstanding as this management team is, it could not really substantiate why there would be a slowdown in 2H. In fact it guided 3Q revenue to $1.70-$1.72bn which compares to a $1.64bn consensus. That suggests a slower 4Q given that it did not meaningfully take up the year (at least not by as much as the 2Q beat and 3Q upside). Translation – it’s being conservative. We’re taking up our top-line growth forecasts given the sheer momentum in the model, and are not assuming that we see a slowdown in growth until next year – but that’s exactly when we think that spending per customer should ramp further and the International story will start to take off. In the end, nearly everything we heard on the conference call strengthens our conviction in this call, and that in spite of the upside we’ve seen so far, there’s still upside over a TAIL duration to $90.
THE HEDGEYE EDGE
Chewy (CHWY) is one of those rare examples of a company with multiple, powerful, multi-year secular tailwinds that is coinciding with a once in a generation cyclical (positive) demand shock, which should meaningfully push it over the goal line cash-flow break even this year (more than the company is guiding) and then GAAP profitability in 2021. Our multi-pronged e-comm ‘model defendability’ framework ranks it above Amazon, and ranks far above players like Wayfair. The category is incredibility defendable with 2x GDP growth and is undergoing an accelerated shift to online – right into Chewy’s sweetspot. It has an upper hand in customer ownership in an emerging online duopoly in the pet space between Amazon and Chewy.
INTERMEDIATE TERM
The general trend for this industry has been pet ownership is on the rise, spending per pet household is increasing, and the shift to online within the category is accelerating (in part due to pet Rx share gain), Under Covid-19 the shift to online consumption is accelerating rapidly and CHWY is growing customers at its fastest rate ever while customers are also spending more. While Amazon competes in the space, it is not as dominant in the category, nor does it have the Brand recognition and consumer’s trust that you have with Chewy. CHWY management is trying to temper expectations, guiding to a slight slowdown in growth in 2H with concern over a pull forward of customer adoption. That may or may not be the case, we think revenue is more likely to surprise to the upside, but regardless the long-term growth trajectory isn’t reliant on the next quarter.
LONG TERM
There are multiple call options embedded in this model. The biggest here is the international growth opportunity, as our outlook has CHWY going to Canada leveraging US DC infrastructure in 2021, and then followed by Western Europe within another 2-years. Our market bifurcation analysis also shows Asia, surprisingly, as a particularly attractive growth opportunity. Then there’s growth into services, pet meds, and private label which all serve as per-customer spend kickers that should take core US online market share to 50% (from 45%) today at a time when the online model is growing its share of pet spend by 400bp-500bp annually. Growth over a TAIL duration is set to re-accelerate given these layers of new business as opposed to mean revert to industry growth rates. Our above consensus estimates don’t even represent our most bullish scenario. The stock is currently trading at 3x EV/Sales – and we think AMZN’s 4x EV/Sales multiple caps CHWY probably at about where it is. But this is an unmitigated growth story – not one we need to bank on multiple expansion. The current business model alone should result in a $12-13bn top line by FY23, or about $80-$90 per share. And while expensive on an earnings and cash flow basis, the catalyst calendar should line up to support the stock.
