When it comes to analyzing an investment, pet e-commerce company Chewy (CHWY -2.83%) seems pretty straightforward. The company attracts pet owners to the platform by offering more than 100,000 products and fast shipping. And it even has autoship options so that users don't forget to buy pet food or medicine on time.
According to the American Pet Products Association, U.S. pet owners are expected to spend $150 billion in 2024. By comparison, Chewy only has $11 billion in trailing-12-month net sales, suggesting it has significant runway for growth. Moreover, the same group says that there are 87 million U.S. households with a pet, and Chewy only has 20 million active customers. This again suggests that the business has upside potential.
However, Chewy is struggling with growth. In the first quarter of 2024, the company's net sales only increased 3% year over year. And its base of active customers actually dropped by about 400,000 compared to the year before.
This lack of growth partly explains why Chewy stock trades at a cheap price. As of this writing, its price-to-sales (P/S) ratio -- a popular growth stock valuation metric -- is close to the cheapest that it's ever been.
CHWY PS Ratio data by YCharts
This is the Chewy investment in a nutshell. Some investors buy shares because of the upside potential with the business. But others are staying away due to its poor growth in recent quarters.
However, there's more to an investment thesis for Chewy than this. Management recently announced something that the company has never done before. And it is material news for investors today.
Chewy is doing this for the first time
With its Q1 report, Chewy's management announced that it authorized a $500 million stock buyback program. It's never done this since it went public in 2019, and it's an interesting development for shareholders.
Think of it this way: Let's say that eight people split a pizza that costs $8. Each person is entitled to a $1 slice. But let's say that two of these people are given $1 each in exchange for their respective slice. Now the pizza only needs to be split six ways, making each slice of the $8 pizza now worth about $1.33.
In the same way, Chewy's market capitalization (the pizza) is $9 billion as of this writing. The $500 million buyback plan could reduce its share count (the slices) by about 6% in theory, which is significant. In practice, it's a little more complicated than this, but hopefully the pizza example portrays the basic gist of the idea.
It's worth noting that Chewy hasn't always been in the position to do this. When it went public, the business was losing money. But through growth, operational discipline, and warehouse automation, it's turned into a profitable company.
CHWY Revenue (TTM) data by YCharts
It generates positive cash flow. This means that Chewy has a responsibility to shareholders: It must use cash wisely to be a good investment opportunity. And management feels like now is the right time to give back to shareholders by buying back stock.
Is it the right move?
Chewy has more than $1.1 billion in cash and equivalents and no long-term debt. Moreover, it's profitable. Investors should also keep in mind that buying back $500 million in stock won't happen all at once -- it will be gradual. In short, the company can afford the move, and it's hard to believe it will turn out badly for shareholders.
Chewy also won't be buying back stock at the exclusion of its other needs. That's good because it absolutely needs to invest back in the business -- investing in customer growth is just one example of its business needs.
There are so many things to like about Chewy's business. But lack of user growth is the fly in the ointment here. Consider that the company had 20.1 million active users at the end of the second quarter of 2021 -- that's nearly three years ago. Zero customer growth in that long of a time period when it seemingly has an enormous opportunity is concerning.
Chewy already spends between 6% and 7% on advertising and marketing, which is unlikely to change. But it will need to become more effective, given its lack of growth.
In conclusion, repurchasing shares isn't a replacement for investing back in the business. Fortunately, Chewy will continue to invest in its business even while it buys back stock. Its strong financial position and consistently positive cash flow allows it to do this, which is good for investors long term.
