What investors missed in Chewy’s Q4 report

IInvestors weren’t thrilled with the latest earnings report from Soft (NYSE:CHWY). The stock plunged immediately after the fourth quarter announcement, spanning the sell-off period through the end of January, as sales and earnings beat expectations.

Chewy’s management team said the shortfall was due to demand and supply chain pressures for pet supplies, which are expected to ease in the coming quarters. But fiscal 2022 will still reflect progress toward management’s ambitious sales and profitability goals.

Let’s take a closer look.

Image source: Getty Images.

Missing expectations

The main concern on Wall Street was that Chewy fell below the 19% increase in sales that most investors had expected. In a conference call with analysts, Chief Financial Officer Mario Marte explained that the loss was mainly due to weaker customer retention in the fourth quarter. The idea spooked Wall Street because it could reflect market share losses or a waning competitive advantage.

That’s not what management thinks is happening, however. Executives say the rise in churn was due to a few unusual things about the group of customers who signed up for Chewy deliveries in late 2020, when the COVID-19 pandemic was at its peak. At the time, demand was geared more towards items such as leashes and feeding bowls rather than pet food, which is purchased repeatedly throughout an animal’s life.

Overall engagement appears strong with a record 71% of customers signing up for subscription orders, suggesting the weak end of the year was an anomaly. “The first year of retention of our Q4 2020 [customers] was lower than what we usually observe,” CEO Sumit Singh said.

Maintenance expenses

Chewy also stumbled on the earnings front as soaring costs hurt profitability. Gross profit margin fell to 25.4% of sales from 27.1% of sales a year ago. Adjusted profit fell to a loss of $28 million from a gain of more than $50 million at the end of 2020.

The e-commerce giant has come under pressure on profits due to labor shortages, rising transportation costs and supply chain disruptions. Leaders aren’t phased by the downturn, however. “We believe most of these challenges are not permanent in nature,” Singh said. Yet challenges have still weighed heavily on 2021 earnings and threaten to pressure margins well into 2022.

The case of a rebound

The good news is that Chewy has everything he needs to reverse this trend. Management expects faster price increases and more cost reductions, so the gross profit margin begins to reach 28% of sales.

It could take a quarter or two before it’s clear that the decline in customer engagement in the fourth quarter was a one-time event. But given the high renewal and order rates overall, it’s likely the slump was simply a consequence of pandemic-related volatility.

As a result, investors who have watched Chewy’s stock from afar might consider buying it after the recent selloff. The e-commerce part of the pet products industry is expected to grow at a high rate over the next few years. Chewy’s dominant position should help it capture more than its fair share of those gains, even if profitability rebounds from the recent decline. It’s a formula for accelerating earnings growth and strong returns for investors.

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Demitri Kalogeropoulos has no position in the stocks mentioned. The Motley Fool owns and endorses Chewy, Inc. The Motley Fool has a Disclosure Policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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