Chewy Reveals Plan for Profitability


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Chewy, Inc. CEO Sumit Singh just laid out a four-point strategy that he believes will lead the company to profitability, but the investment community doesn’t seem convinced—and neither am I.

 

The online retailer’s stock price fell after it delivered, on July 18th, almost all positive news in its first earnings report since becoming a public company in June, including:

 

• Net sales for the quarter increased 45% YOY to $1.1 billion

• Active customers grew 3.5 million YOY to 11.3 million

• Net sales per active customer increased 9% ($315-$343)

 

Of course, this level of growth shouldn’t come as a surprise to anyone who has been watching the company—after all, its sales grew by more than $1 billion from 2017 to 2018. What was more striking in this earnings report is that the company continues to make progress in its pursuit of profitability, pushing its gross margins to a high-water mark of 22.9% and reducing its first-quarter losses by more than 50% year over year ($29.6 million vs. $59.8 million).

 

Still, Chewy has a long way to go before it’s operating in the black, which brings us back to the four focus areas that Singh pointed to when asked about the company’s path to profitability in a call with investors:

 

 

1. Leveraging the Existing Customer Base

“Our active customers that engage with us, the longer they stay with us, the more share of wallet or net sales they spend with us,” said Singh. “That base, to us, is a profitable base. That defines the power of the Chewy model.”

 

This assertion seems to be supported by the fact that Chewy’s net sales per active customer continues to increase at a significant pace (+9% in Q1 of FY2019). Combine that with the fact that the company’s customer base continues to grow year over year and you have a pretty compelling reason to believe that it’s not a question of if the company will become profitable, but rather when.

 

However, I’ve seen no clear data on Chewy’s customer turnover rate, and the company is spending an awful lot of money to acquire new customers. In fact, more than $102 million was spent on advertising and marketing in the first quarter alone. Can the company continue to grow—or even maintain—the size of its customer base without that level of investment in marketing? I’m not so sure, especially given that Amazon has firmly set its sights on growing its share of the pet care category.

 

 

2. Private Label

“Exiting 2018, [private brands] represented about 5% of our sales. We aspire to play north of 15% [similar to other large retail players] over the long term,” said Singh. “At this scale, private brands should be more profitable than our base business.”

 

While the Chewy CEO is correct in assuming that private-label products should be more profitable than branded offerings, depending on these products as a game changer could be the biggest fault in the company’s plan for profitability. Let’s not forget that Chewy has gotten where it is by selling (at a steep discount) many of the top pet food brands in the independent pet specialty channel. I doubt that the online retailer’s American Journey brand will have the same resonance with consumers who are increasingly looking to trade up, not down, when it comes to their pet’s nutrition.

 

 

3. Healthcare

Singh was bullish on Chewy’s prospects in the healthcare category—i.e., pet prescriptions—saying that “greater than 90% of the [healthcare] vertical is addressable by Chewy.”

 

He noted that July marks the first anniversary of the launch of Chewy’s online pharmacy, and he discussed the company’s new “My Prescriptions” feature, which enables customers to view and manage their pets’ prescription medications, including tracking refills and expiration dates. He also announced that Chewy co-located a new pharmacy with its Phoenix fulfillment center in the first quarter of FY2019.

 

This is probably the strongest part of the case that Singh made for the inevitability of Chewy becoming profitable. Prescription medications—and healthcare products in general—carry significant margins, particularly compared to pet food and hard goods. While this category still represents a very small portion of Chewy’s sales, gaining traction here could have a significant impact on its overall business.

 

Still, the company’s plans for the category seem to presume that it will be able to build a great working relationship with the veterinary community—a development that is far from certain.

 

 

4. Mystery “Services”

The most intriguing part of Chewy’s plan to achieve profitability was only hinted at by Singh in the first-quarter earnings call with investors when he referred to “vectors that [Chewy] has not fired on yet.”

 

“In an effort to build a destination for pet parents, when we are ready, you can think about services— types of models that are inherently high-margin verticals,” the CEO teased.

 

What are these mystery services? Could Chewy be contemplating a move into brick-and-mortar? Is a Wag-type online service referral business in the company’s future?

 

Only time will tell what “high-margin verticals” Singh was referring to, but I am skeptical that a company that counts handwritten thank-you notes and custom pet portraits as the height of customer service will be able to pull off a coup in the high-touch world of pet services.

 

But don’t tell that to the CEO. After all, he believes the company is already “… bringing customers the convenience of e-commerce along with the expertise and personalized service of the best local neighborhood pet store.”

 

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