Product shortages put Chewy (CHWY) in the doghouse
18:38, 10 December 2021
Internet pet product retail giant Chewy (CHWY) saw its stock slump to a 52-week low on Friday, 10 December, following the company’s release of its third-quarter earnings the day before.
The report revealed merchandise shortages took a bigger bite than expected out of revenues. Inflation, staff shortages and a higher cost of labour also took a toll on Chewy’s bottom line.
The market reacted swiftly following Chewy’s 5pm conference call for analysts and investors. Its share price dropped in after-market trading to open at $50.30 Friday, down nearly 12% from Thursday’s closing price of $56.30. As the morning progressed, the share price dipped to a new 52-week low of $50.205 before recovering slightly. The 52-week high was $120.
Chewy’s product shortages were particularly pronounced in wet dog food and hard goods. In an effort to shore up supply, the company increased its on hand inventory by $100m (£75.36m) since the start of the year to “protect against further supply chain deterioration and prepare for holiday sales,” said Mario Marte, Chewy’s chief financial officer.
“The negative impact of supply shortages on Q3 net sales was approximately $15m more than our internal expectations,” Marte said.
Pressures on profitability
In an interview with Capital.com on Friday, Needham & Company consumer e-commerce analyst Anna Andreeva said she is cautious about the stock, keeping her recommendation unchanged at “hold”.
“I would love to understand a little more where some of these out-of-stocks are coming from, and why they were surprised, and how they will address it in the fourth quarter,” said Andreeva, who is Needham’s managing director of equity research.
“I worry about the pressures on the profitability coming into next year. Again, labour in fulfillment centers across the country has been very difficult for companies to get, it’s been very tight. I want to understand how much longer that can continue in the next year.”
Andreeva said that in addition to a tight labour market, “it’s a perfect storm in terms of profitability for this company right now” given “freight increases and supply-chain type of headwinds.”
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Labour shortages
Net sales for Chewy’s 2021 third quarter were $2.21bn, up 24.1% from $1.78bn in Q3 2020. Net loss for the quarter was $32.24m, close to last year’s Q3 loss of $32.85m. This past quarter’s net loss included $19.1m in share-based compensation. Adjusted EBITDA – earnings before interest, taxes, depreciation and amortisation – was $6m, an increase of nearly 10% from last year.
Chewy CFO Marte said persistent labour shortages have been a formidable obstacle to achieving a smooth flow of receiving inventory into Chewy’s warehouses, then shipping goods out swiftly and efficiently to customers.
“We entered Q3 expecting to see improvement in labor markets that has not materialized to the extent we expected, and labour shortages continued to hinder our efforts to fully staff our fulfillment centers,” Marte said. “This affects our ability to process both inbound and outbound shipments and to achieve optimal levels of operational productivity. In the face of these macro-driven challenges, we spent more to maintain customer experience in business continuity, which was a drag on Q3 profitability.”
Tails still wagging
In a report about Chewy issued on Thursday titled Not as fast but still wagging our tails, internet stock analyst Mark Mahaney lowered Chewy’s share price target from $117 to $97.
“We came away from the quarter slightly less constructive given the macro triple whammy of supply chain pressure, wage inflation and product cost inflation,” said Mahaney, who is senior managing director of Evercore ISI. “That said, we believe these cost pressures are mostly temporary and we expect the headwinds to abate by mid-FY22 (though labour cost inflation may become more persistent).”
Chewy is working on measures to become more to its customers than simply a supplier of pet products by venturing into health-related services to drive greater customer engagement and brand loyalty, such as a new partnership it forged with Trupanion to sell pet insurance to Chewy’s customers.
Virtual vet consults
Chewy is also offering virtual veterinarian consults 15 hours per day, and the service is free for those who use Chewy’s autoship function – a setting on the site that authorises Chewy to automatically deliver orders at customer-selected intervals. Autoship orders make up a significant portion of Chewy’s sales, totalling $1.56bn in Q3, or 70.6% of total net sales. Autoship sales increased 25.7% from third quarter last year.
Chewy is currently doing a soft rollout of an e-commerce solution for veterinarians to allow them to create, pre-approve and manage medicine and diet prescriptions under a program it calls PracticeHub. Veterinarians earn revenue on orders placed while Chewy handles stocking inventory, fulfillment, shipping and customer service. To date, about 50 clinics have been invited to participate in the program, and Chewy plans to expand its rollout to the vet community in general. Other services such as boarding, grooming and puppy training could be offered using a similar model, the company said.
Analysts like pet health angle
Analysts spoke positively about Chewy’s inroads into the pet health market, citing the fact that in the US, for example, pet insurance penetration is just 2% to 3%, compared to 25% in the UK. Mahaney said products and services offered under the pet health banner could add fruitful sources of higher gross margin revenues,
In an equity research report issued on Thursday, consumer products analysts Stephanie Wissink and Corey Grady of Jefferies wrote that “new offerings in vet, pharma, and services drive deeper penetration of existing pet owner spend.” They gave Chewy a “buy” recommendation but dropped the price target from $100 to $90 per share.
“With impressive growth and a business model that is levered to industry tailwinds, we believe CHWY could continue achieving strong sales growth,” Wissink and Grady’s report said.
But, they added, Chewy also has a significant challenge to face going forward – stiff competition from the mega retailer Amazon.
“AMZN is able to leverage scale and operational efficiency to significantly undercut CHWY on prices, and customers are slow to shift pet supply spend online.”
Twenty million customers
Chewy reported it had 20.4 million active customers in Q3, an increase of 15% from the same period last year. Its NSPAC – or net sales per active customer – was $419, a 15.4% increase over third quarter 2020. NSPAC measures an active customer’s total net sales over four fiscal quarters.
Chewy was founded in 2011 and is headquartered in Dania Beach, Florida.
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