Don’t let Chewy’s recent share price increase scare you away from a long-term investment in an industry leader.
Leading online pet-products retailer Chewy (CHWY 5.81%) has seen its share price rocket 56% higher over the last month. This run might have investors thinking they missed their opportunity to buy shares in the newly profitable business.
However, even after growing its net profit margin from negative 9% in 2018 to 2.3% in its last quarter, Chewy could still be in the early stages of its margin expansion with a focus on higher-margin businesses. Here are five reasons Chewy could see its profitability continue to move higher for years to come, making it an excellent stock to buy hand over fist.
1. Chewy Health
The company has built a $3 billion pet healthcare business named Chewy Health, in addition to its traditional retail sales of pet food and toys. It sells prescription and over-the-counter medicines, supplements, and veterinary diets, and now accounts for roughly 30% of the company’s sales.
These pet health products, used by 20% of the company’s customers, have a gross profit margin 10 percentage points higher than its retail business.
Here’s where things get really interesting for Chewy Health’s potential, though. It is already the No. 1 pet pharmacy in the U.S., but the company has ample opportunity to continue growing its share of the pet healthcare niche as it opens veterinary clinics.
2. The vet clinics
Chewy launched its move into the veterinary space with its first four pet-care clinics in its latest quarter. These clinics could bring new customers to Chewy’s platform while furthering its margin expansion. Today’s Veterinary Business estimates that the average vet clinic in the U.S. maintains a net profit margin north of 10%, a far cry from Chewy’s current 2.3% mark.
This expansion might be welcomed by pet owners and veterinarians alike, given its No.1 spot on Forrester’s Customer Experience Index. With private equity shops scooping up roughly 25% of the vet clinics in the U.S. (despite negative views about it among veterinarians and pet owners alike), Chewy could disrupt an industry now viewed as overly profit-focused.
Image source: Getty Images.
3. CarePlus pet insurance
The company recently partnered with Trupanion and Lemonade to offer health and well-being insurance for pets, an industry that has grown to roughly $4 billion today. The pet medical insurance niche is expected to increase by 17% annually through 2027, with only 3% of pet owners using such an offering, giving Chewy a long growth runway.
Best yet for investors, these insurance sales have no underwriting risk to Chewy and bring nearly 100% gross profit margins due to the terms of its partnerships.
4. Private-label products
The company currently generates only 5% of its total sales from private-label brands, but management aims to grow this number closer to the 15% mark over the long term. Its in-house American Journey and Vibeful brands are designed to foster strong relationships with its customers with value pricing.
They tend to have gross profit margins 7 percentage points higher than comparable national brands despite their lower prices. So the company’s retail margins could gradually move higher as Chewy looks to expand into private-label cat food and starts to market its in-house brands.
5. Sponsored ads
Chewy’s most promising unit could be its sponsored ads business. Chief financial officer David Reeder said, “On a year-over-year basis, our sponsored ads program was the largest driver of our gross margin improvement.”
This program immediately affected the company’s margins after it was launched in the fourth quarter of 2022.
CHWY gross profit and net profit margin data by YCharts.
These sponsored ads already account for more than 1% of Chewy’s total sales but could grow to 3% of the company’s revenue, according to management. They have a gross profit margin of around 70% and have the potential to increase the company’s bottom line as they continue growing.
Why buy Chewy now?
These five margin-expanding opportunities (not to mention the company’s streamlining autoship operations and the steadily growing pet care industry) make for a compelling investment. Best yet for investors, the stock remains reasonably valued with a price-to-sales (P/S) ratio of just 1.
Compared to the S&P 500 Index’s average P/S of 2.5, Chewy’s high-margin opportunities remain discounted, even after the stock’s recent run, making it one of my favorite stocks to buy hand over fist right now.