Risks include high competition and low margins in pet products, but consistent growth in EBITDA and growing transaction value per-customer support a positive outlook.

Chewy (NYSE:CHWY) reported better than expected earnings for the second fiscal quarter at the end of August that went hand in hand with strong EBITDA margins and a favorable customer monetization trend. Shares of Chewy have also revalued sharply higher in FY 2024 as the company's business fundamentals are improving and a meme investor took a position in the pet supply e-Commerce platform. I believe the value proposition is still attractive here for long term investors, despite a near-60% increase in the company's valuation in the last year. The outlook is positive and shares are not too expensive based off of earnings.

I recommended Chewy as a strong buy in June after the online retailer reported first-quarter earnings: A Game-Changing Quarter (Rating Upgrade). In the second-quarter, Chewy remained widely profitable in terms of EBITDA and free cash flow and beat top and bottom-line estimates as well. Key platform metrics such as customer-spend are still growing, resulting in a respectable amount of free cash flow. While I don't expect Chewy to post massive earnings growth going forward, I believe the online pet store is doing a great job growing its business slowly and steadily.

Chewy reported better than expected top and bottom-line results for its second-quarter. The pet-focused retailer realized adjusted earnings of $0.24 per-share on revenues of $2.86B. The bottom line surpassed the average prediction by $0.03 per-share, while the top line came in $3.0M ahead of the consensus.

Chewy continues to execute well on its growth strategy, which includes the roll-out of veterinary clinics, branded as Chewy Vet Care -- as a means for the pet store retailer to diversify its revenue mix and open up a new line of income. Chewy remained widely profitable in the second-quarter and the pet-focused e-Commerce platform generated $145M in adjusted EBITDA in Q2'24, showing a year-over-year increase of 65% as well as an EBITDA margin of 5.1%... the second-highest in the last year.

Importantly, Chewy is raking in a good amount of free cash flow from its customer base. Since pets are a passion niche, one in which customers tend to spend money on in a recurring fashion, which I believe Chewy's free cash flow limits risks for investors.

The company has significantly expanded its operations in the last several years, growing its product suite, focusing on improving customer monetization as well as starting new strategic initiatives with its veterinary clinics. Improving customer monetization trends have been key to the company's top line and free cash flow growth in the past. In the second-quarter, Chewy's customers spent $565 on average on platform products, compared to $532 in the year-earlier period. In other words, per-customer platform-spend increased by 6% year-over-year in Q2, driving top-line growth.

In terms of free cash flow profitability, Chewy has made fundamental improvements in the last several years as well and is now widely profitable based off of FCF. In the second-quarter, Chewy generated $91M in free cash flow, which calculates to a healthy (for a retailer) free cash flow margin of 3%.

(Source: Author)

Chewy's outlook for the full-year calls for $11.6-11.8B in (NET) revenue, which implies a year-over-year growth rate of up to 6%. The online pet store also projects an EBITDA margin of approximately 4.5-4.7%.

I previously pointed to Chewy as an investment opportunity, in part because the retailer's low valuation based off of earnings. Chewy traded at 22.6X earnings multiplier when I last looked at the online pet store in June, which was significantly below the company's historical valuation average.

Currently, shares of Chewy are trading at a price-to-earnings ratio of 25.7X and although a major revaluation has already taken place since my last work on Chewy was published three months ago -- shares are up 41% since -- I believe the retailer still represents attractive investment value. What contributed to Chewy's strong performance was that meme investor Keith Gill, known as Roaring Kitty, purchased close to half a billion dollars worth of Chewy's shares in July.

First of all, Chewy is trading at a 55% discount to its longer term, 3-year average P/E ratio of 57.1X. Further, rival pet company Petco (WOOF) is priced at a much higher 60.7X forward P/E ratio and the estimate trend favors Chewy significantly (see chart below).

In my opinion, Chewy could be trading at a price-to-earnings ratio of 30-32X, which implies a fair value range of $37.35 to $39.84 for the retailer's shares. The revaluation could be driven by further expansion into new product categories like pet pharmacies and veterinary clinics and, potentially, accelerating capital returns given that Chewy already achieves a decent amount of free cash flow.

The biggest risk that I see for Chewy is that its core operations are highly competitive and have a low moat. Pet products are commodities and can be sold by many other companies, including Amazon, which means they tend to have low margins. Therefore, investors should not expect a drastic upsurge in profitability going forward. What would change my mind about Chewy is if key performance metrics like EBITDA and free cash flow margins deteriorated or if Chewy were to see a contraction of its revenue base.

Chewy is no software company whose profitability and valuation could explode overnight. However, Chewy is seeing consistent growth in its core business, which has yielded upside in its customer transactions (improving monetization) and a surge in EBITDA and free cash flow since last year. Chewy executed well in the second-quarter and free cash flow margins remained fairly stable year-over-year as well. I do see more upside potential for Chewy related to its growing platform-spend, and Chewy's valuation remains widely below its historical valuation ratio.