First looked at Chewy (currently the largest pure play online pet retailer) when it got bought out by PetSmart (the biggest specialty pet physical retailer owned by BC Partners) for $3.4bn in 2017. At the time I thought the price tag was excessive. Then in 2019, Chewy IPO’ed at a $9bn valuation. Shortly after, the stock rallied to $15bn valuation. And that’s when we started a short position.
While we did make some money as the stock crashed from mid-to-high $30s back to around IPO price of $22/share, oh boy, the stock went on to rally to $120 in early 2021. As of writing it is settling at ~mid-$70s, giving it an enterprise value of ~$30bn. What made me change my mind was the fact that Chewy was able to rake in such a phenomenal growth quarter after quarter with no signs of slowing down. I underestimated the strong growth profile of even a niche market like the pet industry, and I further underestimated Chewy’s ability to outperform.
Pet Industry
It was estimated that spending on overall pet market has grown from $70bn in 2014 to $100bn in 2020. More importantly the industry is expected to continue to grow at 5-6% a year. It ties to the secular tailwind of pet ownership trends in the US. Spending on pets have become a necessity. People purchase pet products and services frequently, regularly and at increasing premium. They call it pet humanization, and it’s real.
During financial crisis in 2008-2010, while overall consumer spending in the US declined, pet spending actually increased. In the most recent economic downturn as result of the pandemic, pet adoptions and fostering actually surged with “stay-at-home” orders. The pet industry has become one of the most resilient categories in economic downturns.
Just looking at the dramatic expansion of market multiple on pet companies tells the story. PetSmart and Petco (the second biggest specialty pet store chain) both had debt trading in the distressed territories just couple years back with debates on how they might survive in the retail demise. Now both companies have re-financed their ways out, with Petco being able to IPO itself at 13x EBITDA in early 2021 and now trading at ~15x, and PetSmart IPO’ing Chewy at enormous gain. Frankly, rising tides lift all boats.
Pet Retailers
Within the pet industry, the pet retailers compete in around half of the market, mostly in pet food and, to lesser extent, supplies and OTC medicine. Rest of the market includes vet care, pet services and live animals. The retail competitive landscape comprises of (1) mass channels (e.g. Wal-Mart, Target), (2) big box specialty (e.g. PetSmart, Petco), (3) independent and local pet stores, and (4) online.
Historically online pet retailer had a bad stigma from pets.com which blew itself up in the dot com era. In fact Amazon invested in it before it went bust. And generally it’s costly to ship bulky products like bags of pet food. For the longest time, Amazon was the only legitimate online pet retailer. PetSmart and Petco each had its own website but commanded very little online market share. Even then the pet category had never been Amazon’s focus, perhaps until 3-5 years ago, especially with launch of wag.com, its own private brand pet products, in 2018.
In 2014, online shopping of US pet products accounted for only 4%. Today, 27% and keeps growing. As e-commerce logistics infrastructure continues to improve, Chewy saw an opening in an industry primed for disruption and successfully differentiated itself through high-touch customer experience.
Financial Performance and Valuation
In 2016 when Chewy got acquired by PetSmart, it did $900mm of revenue. This year, 2021, the expected revenue is $9bn. That’s 10x in 5 years. While the exponential growth rates will inevitably slow down, I can see its revenue settling in the range of $10-15bn over next couple years.
2020 was their first year recording a positive EBITDA margin. Say eventually they can reach 10%. That would mean $1-1.5bn EBITDA. As it has established itself as the category leader in a resilient industry with fairly loyal customer base and potential expansion into other verticals of the pet market, maybe a 20-30x multiple is appropriate. That would point to say a $30bn valuation, roughly where it is trading. I can’t say I am a buyer nor a seller at this point.
Lastly, as pointed out in my post on GameStop (GME), Chewy original founder, Ryan Cohen, left the company soon after acquisition by PetSmart. (He is now leading the campaign at GameStop to disrupt the gaming e-commerce market). This means last couple years’ strong growth at Chewy was sustained by the current management. You can read more about the CEO here on its website. Lots of things to look forward to. Until next time.
