The COVID-19 crisis boosted both the pet industry and e-commerce as a whole. Pandemic-induced stay-at-home orders made the time-consuming responsibility of owning a pet more feasible for some, and shopping on the internet more appealing for most.
Based on this, Chewy (CHWY 6.17%) -- a company operating at the intersection of pet supplies and e-commerce -- seems primed to deliver meaningful shareholder returns over the long term. Here's why Chewy is a strong buy today.
Impressive performance justifies a lofty valuation
In Chewy's most recent third-quarter results, it excelled across the board. Its sales spiked 45% year over year to $1.78 billion. The company's strong operational efficiency drove a 180 basis point expansion of its gross margin to 25.5%, and its adjusted EBITDA more than doubled to $5.5 million -- both year over year.
According to Chewy CEO Sumit Singh, financial outperformance was driven by especially strong demand. While this could be a temporary boost from COVID-19, there are no signs of the momentum slowing down.
Volumes at the back end of Chewy's most recent quarter saw traffic, conversion, orders, and user retention all handsomely exceed expectations. Looking ahead to the fourth quarter, Chewy's anticipated holiday season could be so strong that it puts logistics pressure on the pet supply organization.
Luckily for investors, Chewy has been preparing for this since the early summer via streamlining inventory processes and prepping fulfillment centers. While this holiday season was invariably a hectic time for Chewy, Singh and his team were ready to handle anticipated surges in demand. The result? Chewy expects to capture more than half of its industry's total revenue growth in 2020.
With a somewhat elevated price-to-sales multiple of 5.63 -- versus an average of 2.74 for the S&P 500 -- Chewy is far from a cheap stock. It will need to maintain strong financial results going forward to continue earning this type of love from investors. There is good reason to believe it can do just that (beyond the company's own projections).
Demographic tailwinds
COVID-19 has prompted younger generations to spend on their pets at a growing rate. Amid the pandemic, roughly 33% of millennials spent incrementally more on their pets compared to just 10% of baby boomers. Additionally, younger generations are more likely to own a pet than baby boomers.
Perhaps even more encouraging for Chewy: Millennials and Generation Z are more willing to splurge on quality pet products than their older counterparts, regardless of young folks' generally lower levels of disposable income.Younger consumers spending more on Chewy's supplies hints at a long runway for continued company growth.
Even more encouraging for Chewy, the same generations that own and pamper pets at a higher rate also are far more inclined to shop online for their pets.
A favorable reality for Chewy's industry translates into a healthy compound annual growth rate (CAGR) of 11.3% for pet e-commerce sales, according to Grand View Research. This is set to power the market to $20.75 billion annually by 2027. With Chewy's standing as the most popular website and also one with a leading market share, its future seems quite bright.
What to do with Chewy
Chewy's valuation is elevated, but deservedly so. Its promising growth and niche within an ideal sector sets it up very well for the long term. Regardless of strong returns thus far, Chewy has a great chance to continue powering solid shareholder profits. For this reason, I think it's a buy.