Chewy Earnings: Decent, but Big Valuation Haircut As We Revise Our Cost of Equity Assumption

Narrow-moat Chewy reported decent quarterly results, with $2.83 billion in revenue and $0.07 in diluted earnings per share edging our $2.79 billion and $0.04 estimates, respectively. The petcare retailer continues to make progress in key areas, with traction in its nascent Chewy ads business, quarterly autoship penetration of 76.4% (up 310 basis points), and $67 million in quarterly free cash flow (up 59% annually) continuing to show positive momentum. Nevertheless, we plan to trim our $27 intrinsic valuation by about 25% as we lift the firm's cost of equity to 9% from 7.5%, a move that we believe better reflects its sensitivity to systematic risk. More concretely, an absolute decline in pet households in 2023 and sluggish hard goods sales amid economic pressure appears suggestive of medium, rather than low revenue cyclicality. Absent that change, we'd plan to reduce our valuation by just a low-single-digit percentage on cautious 2024 guidance. Despite the haircut, shares look attractive, and Chewy remains one of our top picks in the online commerce space.