Shares of the pet stock bounced after its latest earnings report. Can it keep rallying?
Like other businesses that benefited from COVID-19, the pet supplies sector soared during the early stages of the pandemic only to come crashing down. Industry leader Chewy (CHWY -3.65% ) was a victim of that sell-off.
After soaring from its initial public offering (IPO) price of $22 to an all-time high of $120, Chewy has given up all of those gains and is trading at nearly the same price it listed its shares at five years ago.
Despite the disappointing slide over the last few years, Chewy remains one of the most promising growth stocks in the pet industry; the business continues to expand though its valuation has come down substantially.
With that in mind, let's take a look at the reasons to buy, sell, and hold Chewy stock.
Image source: Getty Images.
Forget the recent underperformance: Chewy is still far and away the market leader in pet online retail, having successfully taken the niche from Amazon. Chewy is a must-have partner for any pet product seller.
In other words, the company has an economic moat. And it still has a substantial growth opportunity as it takes market share from brick-and-mortar channels like supermarkets.
Chewy is approaching a $12 billion revenue run rate, and its profit margin has improved substantially over the last few years. In fact, its net income based on generally accepted accounting principles (GAAP) tripled in its first quarter to $66.9 million, bringing its price-to-earnings valuation down to about 120.
While its overall growth has slowed significantly, in part due to the pull-forward effect of the pandemic when pet adoptions spiked, the company sees signs that household pet formation trends are improving. Meanwhile, the company has opportunities to expand beyond conventional online retail into areas like healthcare and insurance. And it could leverage the advertising potential of its platform, much as Amazon has to great success.
"Sell Chewy stock" would have been good advice at pretty much any point in the last three years, and some of those reasons still hold true.
For example, its growth rate has slowed to a crawl: Revenue increased just 3.1% to $2.88 billion in the first quarter. The company expects top-line growth to slow even further to just 2% to 3% in the second quarter. For the full year, it's calling for growth of 4% to 6%, though that includes an extra week in the fiscal year calendar. Without the extra week, its growth would be closer to a range of 2% to 4%.
Some of those headwinds are due to the macro-level slowdown in pet adoptions and overall growth in the sector. But they also seem to reflect a maturing business for Chewy, and management doesn't seem to have a credible plan to reaccelerate its growth.
In light of this reality, the stock is likely to keep falling without a significant increase in its top-line growth rate.
Finally, the best reason to hold Chewy stock is the uncertainty surrounding the business.
A number of pet stocks surged over the last month, including Freshpet and Petco Health and Wellness, in response to signs the industry could finally be turning the corner after a long pandemic hangover.
However, it's too soon to be sure, and that recovery isn't apparent in Chewy's guidance. The company is still growing sales per active customer, which were up 9.6% in the first quarter, but it's losing customers overall at the same time.
Holding the stock for a few more quarters could give Chewy investors enough time to see how these dynamics play out.
Chewy's shares jumped after its latest earnings report as investors were impressed with its improvements on the bottom line. But its revenue guidance was still below expectations, and that will likely drive the long-term performance of the stock.
For that reason, I'd give Chewy a rating between a sell and a hold. Revenue growth could bounce back as the pet sector strengthens, but until then, investors should treat the stock with skepticism -- it's still very expensive, given its profitability and growth rate.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Chewy, and Freshpet. The Motley Fool has a disclosure policy.
