Chewy – HEEL!
Chewy, Inc. ($CHWY/NYSE) is a recent IPO that has all the makings of a train wreck for minority shareholders.
The Company raised several hundred million dollars in its initial public offering of 46,500,000 @ $22/share; however, the bulk of proceeds were taken by Chewy’s owner Petsmart and sponsors. Petsmart maintains majority economic and voting control through super-voting shares and will be free to sell more of its 273,500,000 shares on December 15, 2019 when its lock-up agreement expires.
The stock is buoyed by an overheated market and incomplete and misunderstood information, including inflated e-tailer comparable valuations such as ETSY ($ETSY/12x sales) and Amazon ($AMZN/50x EPS), a minimal beat to the guidance given in the Company’s SEC filings (reported as a miss by news services), a belief that auto-reload revenues (67% of sales) are sustainable into perpetuity (in fact cancelable at any time), views that repeat customers will continue to increase spend (the law of large numbers catching up now), and an overall avoidance (or ignorance) of the significant competitive threats around including WalMart’s ($WMT) launch into the pet care space with thousands of in-store vet clinics with PetIQ (VetIQ of $PETQ).
Repeat business and rising average spend per customer have been drivers of growth, but we believe this trend by existing customers has peaked and the law of large numbers will now decelerate top line growth. Note that management’s first post-IPO guidance calls for low single-digit % top line growth in the next three months as per the most recent report.
The Company is free cash flow negative and has little leverage in its operating model especially in a commodity pet food/products world demanding next day shipping from the likes of $AMZN, $WMT and $TGT. The market is characterized by substantial price competition which shows no sign of abating. Despite the fallacy of the argument, pet owners’ loyalty to their animals does not translate to loyalty to $CHWY products and services or its brand. With less than $150MM in cash and burning funds for the foreseeable future, we believe there is little room for error for this online kibbler as it navigates its way to the world of the “big dogs.”
There is no fundamental basis for an online pet food company to trade at $13BN valuation or 3x sales while burning cash. We recommend investors SELL $CHWY based on an IPO that has essentially taken a bankrupt company public while allowing its control shareholder to unload hundreds of millions of dollars of paper in an unprecedented sign that the overall market is in a “second dot.com bubble”. Our price target is $11, which represents 1x annual revenues of $4.4BN based on roughly 400MM shares outstanding. That said, current Internet multiples are inflated, and in a normalized environment, we estimate CHWY shares are more fairly valued at 2x gross profit or 0.5x-0.6x sales, which represents an EV of $2.2BN-$2.5 or $5-$6 per share.
