Chewy, Inc. (CHWY, Financial), a leading retailer in the pet care products and services industry, reported first-quarter earnings results on June 10. The company surpassed both Wall Street analyst expectations and its guidance and reported earnings of 9 cents per share against expectations for a loss of 3 cents per share for the first quarter. However, this strong performance failed to lift the shares higher as the company confirmed claimed that it is facing supply shortages.
Commenting on this challenge, Chewy CEO Sumit Singh said:
“While we are pleased with our net sales in the quarter, elevated out-of-stock levels were a persistent headwind throughout the quarter and reduced our Q1 net sales by an estimated $40 million. This is clearly a supply-driven situation, which we expect to abate in the second half of this year as additional production capacity comes online. Until then, we will keep actively managing our inventory and using our recommendation engines to help customers find attractive alternatives.”
Despite the current challenges, Chewy is well-positioned to benefit from the increasing demand for pets and the growing popularity of the online retail industry.
First-quarter earnings recap and company outlook
The company reported $2.14 billion in revenue, up 32% year-over-year. The adjusted EBITDA was $77.4 million, and the net income came in at $38.7 million. Active customers climbed by 4.7 million to 19.8 million at the end of the first quarter, while net sales per active customer climbed by $31, or 8.7%, to $388. The company generated $59.5 million in free cash flow in the first quarter.
Exhibit 1: Net sales and net income
Source: Investor Presentation
Elaborating more on the challenges faced by the company, CEO Sumit Singh said:
“As we executed Q1 with rigor, we faced labor shortages in our fulfillment centers, or FCs, similar to those being faced by many companies nationwide. To offset these headwinds, we did a few things concurrently. We invested in higher wages and short-term incentives, which to some degree helped overcome FC staffing constraints. We also implemented other operating cost disciplines. We introduced part-time shifts to better optimize interval-level labor forecasting and provide more flexibility options to our team members. These activities helped keep operating expenses in check.”
In the first quarter, the company's hard goods, proprietary brands, specialty, and health care verticals continued to strengthen amid improving consumer engagement. The company relaunched the chewy.com homepage and subsequent stops in the purchasing funnel into a one-page application to improve the buying experience. With Freshpet and Tylee's, Chewy is entering the fresh and prepared pet food market as well, which is likely to help the company report strong revenue growth in the coming years. The company was also awarded PCAB accreditation, which is the industry's gold standard for quality and safety compliance in the compounding industry. Chewy is also expanding into pet adoption services allowing Chewy and non-Chewy customers to discover and adopt a pet through the company’s website.
Under Petscriptions vertical, nearly 7,000 clinics and veterinarian partners are currently using the platform to simplify and automate all prescription administration chores with a simple, easy-to-use digital solution, and the continued adoption of this platform will help the company report double-digit growth in the next few years.
As confirmed by the company management, Chewy is setting itself up as a one-stop shop for everything related to pet care, and this approach could help the company develop long-lasting competitive advantages.
Industry outlook
The last year was unfavorable for many industries but the e-commerce and pet care business sectors thrived as a result of the global lockdown. In response to the public health emergency measures, pet ownership rose in 2020 as people who were confined indoors adopted pets to pass time. According to research conducted by National Geographic, the demand for adopting or fostering pets has risen dramatically as people have turned to pet adoption to cope with pandemic-related stress. The repeated lockdowns boosted demand for pet services and products, propelling the pet care business to new heights.
According to Technavio, the pet care industry will grow at a compounded average growth rate of 5.18% through 2025. Global pet adoption and the growing awareness of the importance of pet health are primary drivers of the global pet care e-commerce sector. According to Research and Markets, the popularity of pet fashion among pet owners will have a major impact on the growth of the pet care market in the North American region, which is the most important geographic region for this market. Pet food is becoming increasingly popular among American consumers owing to the growing concerns related to obesity in pets such as dogs and cats. The Association for Pet Obesity Prevention estimates that 55% of dogs and cats in the United States are obese. This concerning issue will likely encourage pet owners to spend more on fresh food and quality products, which would be a catalyst for the growth of this industry.
Overall, the macroeconomic outlook for the pet care industry is promising, and Chewy is well-positioned to convert these favorable conditions into strong earnings growth.
Takeaway
Although a supply disruption hurt Chewy's sales in the first quarter of 2021, the company still has room to grow, and this temporary challenge is highly unlikely to pose a meaningful threat to the company’s profitability in the long run. Chewy is constantly investing in improving inventory, productivity, and customer engagement, and has established itself as a major player in the online pet retail space. The industry is still at a very young stage, and Chewy’s dominance is likely to help the company develop strong competitive advantages in the future, which could then be used to secure economic profits for a long period of time.
