• Brett Schafer

Chewy: Not So Deep Dive

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Show Notes

(Ryan) What they do: Chewy is a pure-play ecommerce business for pets. It has some other elements to the business, but the majority of revenue comes from selling pet products like food and toys. They do have some in-house brands, but they also partner with about 2,500 other brands in order to stock their digital shelves.

They have fulfillment stores scattered around the country. They can ship to 80% of the US in less than a day and 100% of the US in 2 days. If a customer’s order is higher than $49, they get free shipping. They’re also a company that really seems to pride themselves on customer service. So when someone’s pet dies, they send them flowers. That kinda thing.

Most pet supply purchases are made on a recurring basis apparently, so they also offer a subscription. But aside from the e-commerce offering, they’re trying to be a single online destination for all things pets. They have a telehealth type service for connecting with vets, they have a pharmacy, really anything you could need for a pet.

(Ryan) History: Chewy began operating as Chewy.com in 2011 in Fort Lauderdale, FL. The company was founded by Ryan Cohen who said he was inspired by Jeff Bezos’ 1997 Amazon shareholder letter. He actually wrote a really interesting article on Harvard Business Review which is worth a read.

So he initially launched Chewy with Michael Day using his own cash and a small loan. When he was trying to find some startup capital he went out to Silicon Valley and went door-to-door trying to get VC money. Everyone turned them down. Finally, a gentleman named Larry Cheng gave them $15M and they started scaling up. He said that funding was the high point of his professional career.

However, in 2017 they sold the company to PetSmart for $3.35B. It actually started as an online jewelry store but they pivoted to a pet store literally a week after the launch. But in February of this year they were spun off by PetSmart and are now an independent public company. And they IPO’d in June, 2019.

(Brett) Industry/Landscape/Competition:

  1. Going to classify them in the broad US pet industry

  2. 2018 spend: $90 billion. 2020 spend: $99 billion. So growing market

  3. Vet care was $30 billion of the spend

  4. Competitors: Petco, Pet Food Express, Amazon, traditional retailers

  5. I found a lot of smaller copycats, even some doing meal subscriptions for pets. Also things like BarkBox. Pet industry seems very trendy among “tech” startups at the moment

  6. Pet health market is pretty crowded. You have Zoetis, individual pet practices, lots of drug companies, Trupanion, IDEXX Laboratories. We can discuss what obstacles Chewy may face trying to push into this industry

(Brad) Management and Ownership:

CEO and Director Sumit Singh

  1. Previously:

  2. COO of Chewy

  3. Director of Consumables at Amazon

  4. General Manager of N American merchant fulfillment & 3rd party business at Amazon

  5. Manager at Dell Technologies

CFO Mario Marte

  1. Previously

  2. VP of Finance and Treasurer at Chewy

  3. VP of Fin Planning and Analysis at Hilton

  4. Divisional Controller at American Airlines

  5. Senior Consultant at Accenture

GC Susan Helfrick

  1. Previously

  2. Assistant GC & VP at Goldman

  3. Managing Director at HSBC

  4. Director at UBS

CTO Satish Mehta

  1. Previously

  2. VP Data and Analytics Solutions at UNH & same role at Staples

  3. Senior Director at Yahoo

BOD highlights

  1. BC Partners has 5 board seats

  2. CFO of Best Buy

  3. CFO at Williams-Sonoma

  4. CFO at Dole

  5. Audit committee of Advance Auto + Signet + Stitch Fix

  6. CEO of PetSmart & BOD at GameStop (oy)

Ownership

BC partners appears to own virtually all of the class B stock here & have virtually all of the voting power. Class B = 10X the voting power of Class A.

Insiders and executives not involved with BC own just 1.3% of the company total and in all class A shares.

Morgan Stanley + Baillie Gifford + Vanguard own 24.6% of outstanding shares.

(Brett) Valuation:

  1. Market cap of $37.1 billion, ticker CHWY

  2. Trailing P/S of 4.84

  3. Trailing P/GP of 18

  4. Not any relevant earnings/CF numbers, but it looks like around 10% profit margins are doable here at maturity

  5. About 15 mil in options vs. 415 million shares outstanding

(Ryan) Earnings:

  1. Q1 revenue of $2.14B, up 31.7%

  2. Gross margin of 27.6%, up 420 bps YoY

  3. Net margin of 1.8%

  4. $59M in FCF, or 2.7%

  5. Spending roughly 1% of sales on SBC, so cash flow is a decent proxy here.

  6. 19.8M active customers, up 32% YoY

  7. Autoship customers are growing at 34% YoY

  8. Net sales per active customer grew 8.7% YoY, and sits at around $388

(Brad) Balance sheet and liquidity:

They have $637 million in cash and they’re very profitable from an OCF perspective.

$402 thousand in total interest expense

-$700 million in net receivables. Company uses these trade accounts to finance inventory.

Another 12.4 thousand shares in unvested PRSUs (performance vesting conditions). These will vest over time so very little dilution

Another $400 million in inventory

Credit revolver for $400 million of which most has not been drawn.

Paying .25% to .375% on undrawn credit maturing in 2024

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Anecdotal Evidence:

  1. (Ryan) Made an account this morning. It’s an intuitive website, lots of first-time order discounts, and has pretty much everything you might need for any type of pet.

  2. (Brett) Autoship seems like a great feature, customers seem to love them. And they actually get autoship right (Amazon’s isn’t a very robust offering).

  3. (Brad)

Future growth opportunities:

  1. (Ryan) Proprietary brands. The “Amazon basics” for Chewy. It’s currently outpacing the growth of the overall business and it has to be higher margin since that’s reflected in the gross margin uptick. Looks like they’re discounting their in-house brands pretty heavily too based on the website, or at least the first order. Which is great because once you get your pet on a certain type of food it’s good to stick with it.

  2. (Brett) Chewy Health and “Connect with a Vet.” It expanded its online vet offerings this May with video consults, preschedules, and extended operation hours. This is a tough adjacent market to go after, but I think it can help accelerate the core business (no doubt these licensed physicians are recommending Chewy products for their patients).

  3. (Brad) I think ARPU has a long way to go. The younger the generation, the more likely we are to have a pet and the more we are willing to spend on our pets as well. There is a clear macro-tailwind here to enjoy.

Highlights and lowlights:

  1. (Ryan) Highlights: It’s a pretty resilient business model. Not much seasonality/cyclicality. Once you start buying pet supplies in a certain way, those habits pretty much just tend to stick. The sending flowers when a pet dies is brilliant. People tend to replace pets with more pets, and that seems like something that should build customer loyalty. Lowlights: Don’t really have one. I guess Petco has a pretty sizable footprint and has e-commerce offerings so that could be a bit of a threat but I don’t think it’s zero sum. (Bit of a Walmart/Amazon dynamic)

  2. (Brett) Highlights: Strangely, reminds me of Peloton in the way Chewy takes care of its customer base, pet market is a perfect “niche” that the big boys won’t focus too hard on but still provides a strong opportunity. Without any hard numbers I feel like customer retention is strong. Lowlights: Margins are the big one for me. Other than that really hard to find any problems with their strategy.

  3. (Brad) The branding is phenomenal. Ordering pet supplies from a place called Chewy just feels right obsession w/ users is a compelling combination. But other than that the balance sheet is pristine & they’re profitabie is strong so this company can get very creative and aggressive (pet metaverse? kidding). Lowlights is Ryan Cohen and the Board Member who also serves on GameStop’s BOD. That company is toxic. Any association with them is a concern for me even if Cohen is no longer involved that board member is.

Bull Case:

  1. (Ryan) The 5-6% estimated category CAGR happens. Chewy eats more market share of pet spend. The core business reaches 10% FCF margins and the healthcare initiatives serve as a more profitable call option on the business.

  2. (Brett) In order to believe in long-term stock performance, I think you have to believe Chewy can eventually get to $50 billion in annual sales on 10% profit margins. Doable but tough. That could mean 50 mil customers spending $1000 a year.

  3. (Brad) Chewy becomes the ubiquitous brand for pet supplies across the World. It becomes the leader in scale so can profitably undercut the competition and take share with a similar predatory pricing model that Walmart used so effectively.

Bear Case:

  1. (Ryan) Not really any crazy bear case. I think the current customers are here to stay and spending is quite resilient. I think the worst case scenario is that the alternative products don’t pan out and the top line growth barely exceeds category spend. If that occurs it could be a mediocre business, but I don’t think this is a ridiculous valuation.

  2. (Brett) One word: margins.

  3. (Brad) I really don’t think this will happen, but the company could get “Amazoned.”

Our Sunday Deep Dives are sponsored by Potential Multibaggers. Looking for stocks that have the potential to go up 10x over 10 years? Check-out Potential Multibaggers on Seeking Alpha or on Twitter @FromValue

Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.

#Chewy #CHWY

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