Chit Chat Stocks - Chewy (CHWY) | Not So Deep Dive

Episode Date: August 1, 2021

Chewy is an American online retailer of pet food and pet-related products. The online company sells over 2,500 different brands. Chewy was acquired in 2017 by PetSmart for a whopping $3.35 billion. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Chewy. Enjoy the show! Our Sunday Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Brad’s work? Follow him on Twitter: https://twitter.com/StockMarketNerd?s=20 Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (2:35) Industry | (6:48) Management & Ownership | (9:10) Valuation | (12:46) Earnings | (13:38) Balance Sheet | (15:58) Our Analysis | (17:40) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Sunday Not So Deep Dive episode, a 30 to 40 minute podcast where you can get the basics of a stock, learn about it. We're going to flip over this rock together. We have

Brad Freeman on the show and you chose Chewy for your stock this week. Why did you choose it? uh how to come up on your radar yeah uh so just seeing all the the chewy boxes um in my house i'm a grad student who lives with his parents so um but uh seeing all the chewy boxes at my mom and dad's house just i mean it's it's a pretty pretty easy bull case and and seeing them around the neighborhood just keep my interest they're helping that uh the annual revenue per customer rate that we're going to go over they're they're helping that skyrocket right oh yeah oh yeah uh all right we're gonna talk or sorry i'm gonna let ryan get into the story or the company excuse me can't talk today but first we have to talk about our friends at potential multi-baggers

potential multi-baggers is a service looking to find stocks they can go up 10x over the next 10 years or compound at 26 per year chris our friend who has been on the show before he might go under his pseudonym from growth to value you can check out be on again he will be on again because he's an expert on a lot of these companies he's the founder of potential multi beggars but he gets help from his team of mark and trung they also write articles on the platform there is a chat community where you can ask questions to chris or other multis uh that's what you you know call yourself and then you can you know share your doubts successes everyone kind of communicates together to talk about some of the picks they have. So there's an overview every week. I mean,

it's a very robust, I guess is the word I'm thinking of community. So if you want to be a part of it, if you want to become a Bolte, you can go to Seeking Alpha and look up From Growth to Value, Google it, or go to at From Value on Twitter. All right, Ryan, do you want to discuss Chewy, give an overview of what the company does? Yeah. So they're basically a pure play e-commerce business for pets. And so it has some other elements to the business as well that we'll talk about. But the majority of revenue comes from selling pet products like food, toys, treats, anything pet supplies related. And it's not just dogs, it's cats, reptiles, horses. It really has quite the plethora of options. That horse tan. Yeah. Make sure to put that in your DCF. But they

do have some in-house brands, but I think the majority of their sales come from their partners. So they have about 2,500 other brands that they stock on their digital shelves. I think what's the one that they used to have all those commercials for? Blue Buffalo. Blue Buffalo. Yeah. Organic stuff. You know that the wealth inequality is getting high when we're marketing organic dog food, but keep going. And so they have fulfillment stores scattered around the country. they can ship, uh, up to 80%. They can ship to 80% of the U S in less than a day and a hundred percent of the U S in two days. Uh, and if a customer's order is higher than $49, they get free shipping. So I went on and made my account this morning. It was kind of just looking at

stuff. Uh, they really do pride themselves on customer service and customer centricity. They're not going to, they're not going to lose to Amazon on the logistics stuff. Most other e-commerce companies, you're like, Oh, like way worse than Amazon on shipping and fulfillment and cost and all that stuff. Chewy's pretty good. Yeah, they are. And I think the reason we're going to talk about it, they've gotten to a decent size now. And the reason they've been able to do that is because of the customer centricity focus that they've had. And I know a lot of people say like, oh, we really care about our customers. But for example, they send when someone's pet dies, they send them flowers. That kind of thing is going to

keep customer retention pretty high. And then most pet supply purchases are made on a, or a lot of them are made on recurring basis. So I guess, you know, you buy dog food the same time of the month, every month or whatever. So they also offer a subscription to kind of supplement their typical e-commerce offering. And then aside from the e-commerce stuff, they're trying to be a single online destination for all things pets. So they have a telehealth type service, which Brett will talk about, and that's like connecting with vets. They have a pharmacy. So they sell medication as well. Really anything you could need for a pet. They have like blogs to kind of answer questions. is a pretty comprehensive sort of online pet destination.

And then history is actually pretty fascinating. So Chewy began operating as Chewy.com in 2011 in Fort Lauderdale, Florida. The company was founded by Ryan Cohen, who's a pretty popular figure now. And he said he was inspired by Jeff Bezos' 1997 Amazon shareholder letter, where he talked a lot about just being customer focused.

And so he wrote an article kind of highlighting how he founded the company on the Harvard Business Review that I think is worth reading for anyone that wants to hear his story. But he initially founded Chewy or he initially launched Chewy with Michael Day using his own cash and a small loan. When he was trying to find some startup capital,

he went out to Silicon Valley and actually went door to door trying to get VC money. Was shut down by just about everyone. They were probably, I mean, you'd probably have that sharp reaction, you know, pets.com, you know, like get out of here, kid.

He talked, they talked about that. They got that reference all the time. pretty much a different, and he basically rebuttaled that with, this is a different day and age. That was kind of premature. But Larry Chang eventually gave them $15 million and he called that the high point of his professional career because they started really scaling up after that. However, in 2017, they sold the company to PetSmart for $3.35 billion. I believe that's when Ryan Cohen got out. And then it actually, kind of just an anecdote, It started as an online jewelry store, but after a week of launch, they pivoted.

So Ryan Cohen is kind of all over the place. If you follow him on Twitter, you've probably noticed that. But in February of this year, they were officially spun off by PetSmart. So they're an own independent public company. They IPO'd, I think, in June of 2019. So it's been around for a little bit now. Yeah, I'll hit industry and competition quick. I'm going to classify them in just the broad U.S. pet industry.

in 2018, US pet spending was $90 billion. In 2020, it was estimated to be $99 billion. So growing market, but not rapid. And it's not going to, it's not like, I don't know, it's not a business industry that's going to turn into a trillion dollars anytime soon, at least I wouldn't guess. And if we go a little bit deeper into it, there's a reason why they're trying to get into vet care and healthcare and the pharmacy stuff, because vet care was $30 billion of that spend. Competitors are, you know, they range far and wide. There's Petco, Pet Food Express, Amazon, other traditional retailers. I mean, a lot of any big box retailer is going to be selling dog food. I found a lot of smaller copycats and there were some

doing even meal subscriptions for pets. I don't know the long-term viability of a lot of these. there was at least 10 of them um and it feels like a silicon valley episode i i it's trendy right now and the tech startup kind of scene yeah we'll make it up in volume i guess uh let's see there's also one like bark box seems interesting it's kind of a competitor i think they just give out random toys on a subscription service to your dog so that could work but yeah very crowded right now um truly is definitely the leader in any of these new age ones uh but we'll see they have a lot of competition and then if you want to go into the pet health market it is also pretty crowded you have zoetis you have a lot of individual pet practices there's a ton of drug companies out

there there's chupanion which is pet insurance that's pretty small company and there's idex laboratories i don't know exactly what they do but they are a public company as well we can kind of discuss later what the obstacles are that chewy might face you know pushing into the health care side but there are there are a lot of legacy players there i would say their biggest competitor is probably just petco if you've listened to the business breakdowns episode with patrick they talk about petco and sort of the the footprint it has it's really a big retail store and then obviously sort of your typical brick and mortar retailers like at least for pet food, like Costco, Safeways, Walmart, Amazon. Yeah, for sure. All right,

Brad, do you want to hit management and ownership? Yep. So not founder-led, but the current CEO and board of director is Sumit Singh. So I'm sorry if I mispronounced that. I think it's Singh. Okay. We're going to go with Singh. Sumit Singh. So he was previously the COO of Chewy. So he has a lot of experience with the company before he was promoted. He was a director of consumables at Amazon. He was a general manager of North American merchant fulfillment and third-party business at Amazon, and he was a Dell Technologies manager. I listened to a bunch of his interviews. I normally listen to CEOs and love them, and this is no different. I guess I'm a pretty easy target for CEOs to make me like them, but he seems like a really down-to-earth guy and a very capable

human being at the same time. But CFO is Mario Marte. He was previously the VP of Finance and the Treasurer at Chewy before he was promoted. He's been the Vice President of Financial Planning and Analysis at Hilton. He was a Divisional Controller at American Airlines and a Senior Consultant at Accenture. So pretty good experience there. The General Counsel was previously the Assistant General Counsel and a VP at Goldman Sachs. The Chief Technology Officer used to be the VP of Data and Analytics Solution at UnitedHealth and Staples. So a lot of really impressive experience throughout the executive team. Interesting notes on the board of directors, BC Partners has five board of director seats. So they have a very large presence. Some other

highlights, the CFO of Best Buy, the CFO at Williams-Sonoma, the CFO at Dole. Yeah, a really well-rounded board of directors, a really well-rounded executive team. In terms of ownership, so BC Partners, as you may have expected by them having five board of director seats, according to their most recent proxy statement, BC Partners owns virtually all of the Class B stock here. And so they have virtually all of the voting power. Class B comes with 10 times the voting power of Class A shares. Insiders and executives not involved with BC just own 1.3% of the company. So kind of similar to PayPal, which we did a month ago or something like that. When there's a large exit, which there was here, it's pretty typical that insider ownership is

pretty low. In terms of institutional ownership, you got your typical bellwethers, Morgan Stanley, Bally Gifford, Vanguard at around 25% of the float. Gifford, yeah. Gifford's in so many stocks. I mean, that's such a big fund. Ryan, did you have anything? I was just going to say, I assume you got this from the latest fiscal year 20 or the latest fiscal year proxy statement a lot of this is probably going to change since the liquidation or the pet smart spinning pet smart spinning them off came in february of 2021 so like yeah so it might change yeah but it is interesting that that one outside fund or maybe they're technically an insider whatever but they held you know all the voting power it's kind of a weird dynamic um they're they're very involved with uh what was

called pet smart so so it makes um it makes some sense and just for our viewers uh for their awareness this proxy proxy statement was from may of 2021 so yeah um that's a good point it could be changing with with that with that liquidation i guess i would have came right after but yeah it'll be weird but either way this isn't where you're not looking that this is like a founder you know story. Whoever owns it, it's not going to be a giant deal. All hit valuation market cap from when we're recording is $37.1 billion. Ticker is CHWY. Trailing price to sales of $4.84. Trailing price to gross profit of $18. So fairly low margins here. Not really any relevant earnings or cash flow numbers. They were profitable. Yes, they were profitable last quarter and they were

cashflow positive, but looking at their margin structure, probably, you know, something like 10% profit margins are doable here at maturity. We can probably, we'll get to that in the second half and maybe discuss whether that's too high or too low. And then just another note on the valuation, they have about 15 million in options outstanding versus 415 million shares outstanding. So not a crazy amount, but there will be as usual, you know, some stock option headwinds with this company? Ryan, you want to hit earnings? Yeah, I'm just going to hit the first quarter stuff. So first quarter revenue was 2.1 billion, up 32% year over year, and they had gross margins of 27.6%. That actually grew 420 basis points or 4.2% year over year. And then net margins of just under 2%,

but they had 59 million or so in free cash flow. That's about 3% free cash flow margins. So as you said, it's kind of early in the margin conversion. And that free cash flow margin has improved each year of each of the last three years. And then they're spending about 1% of sales on stock based compensation. So cash flow is actually a decent proxy for profitability here. It's not like they're masquerading it or anything like that. And they had 19.8 million active customers up 32% year over year, auto ship customers are growing just slightly higher than that. And then net sales per active customer grew almost 9% year over year. And it sits at around $388.

As far as trailing 12 months, just to give people an idea, it's about $8 billion in sales And they're guiding for $9 billion this fiscal year, if I remember looking at the shareholder letters. So, I mean, decent. It's all running. Yeah. Nothing to complain about. Nothing was like, whoa, that's crazy.

But everything. It's like, yeah. Yeah. And keep in mind, COVID gave them a pretty big boost because obviously pet food spending is pretty resilient. It's kind of a necessity. And a lot of people had to do it digitally. So some of the year over year comps look, I mean, I guess they've stuck around, but comps might get a little worse, at least growth in the second quarter, third quarter. Yeah. Brad, you have something? Yeah, we also saw those really heartwarming and encouraging stories about dog shelters emptying out during the pandemic because people had more time on their hands. So hopefully that was a durable trend, but that could be another tailwind for them.

And I'll also say on the fallout, on the back half, there was articles that said like people are sending the dogs back to their shelters. The shelter said that's not true. There was rebuttal articles. There's just probably some people that, that's a good clickbait headline. Yeah, so good for the dogs. and I guess good for Chewy. Good for Chewy. Yeah. We're going to get that pet spending up, right? That's what we want. Brad, do you want to hit balance sheet, wrap up the first half? Yep. Pretty darn strong here. So they have $637 million in cash on hand and equivalents.

And like Ryan and Brett were talking about, they are cashflow positive, and that is pretty real. That cashflow is pretty real. They have negative $700 million in net receivables. For a company like this, it's not super concerning. They use their trade accounts to finance inventory. So don't pay too much attention to that. I'm not paying too much attention to that. They have another 12.4 thousand shares in unvested PRSU. So these are performance vesting conditions. So virtually zero dilution from from the equity standpoint. But as Brett was talking about, there's also some options out there that that will have that will create some more dilution. They have another 400 million in inventory and no debt, but they do have a credit

revolver, or I guess very little debt, I should say. They have a credit revolver for $400 million max, of which almost all of it has not been drawn down. So that's where I say almost none instead of none. They're paying 0.25% to 0.38% on any undrawn credit maturing in 2024. And then there's one more thing that I wanted to talk about. Oh, and then $402,000 in total interest expense. So really, really not a huge consideration there. And they've got a ton of flexibility to do what they want to do. Yeah, the most interesting thing about them was not an expert on Amazon, but I think the balance sheet is similar to Amazon's where the working capital is almost negative most of the time. And some people can get concerned about that, but it's just because they have a lot of payables since they're buying stuff from people, shipping it to customers.

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Restrictions apply. Okay, welcome back. Anecdotal evidence, Brad. You kind of gave yours away, but have you used the website before? Or is it just someone in your family that's used it? I have not personally used the website, but my mom, who I trust and love very much, uses it and loves it. So I'm going to go with two thumbs up on her behalf. All right.

She's got good lifetime value to it. Nice. All right, Ryan. I made an account this morning. It's a really intuitive website. There are a lot of offerings, a lot more than I was expecting, a lot more different for all types of pets. And then there's also a lot of first time order discounts, which I think is a good idea. I'll get into it and I'll explain why. But, yeah, I'm kind of a dog person myself. I could see myself using this. If I had a dog to myself, I guess it belongs to my parents. So, yeah, I thought the website was good.

Yeah, I agree. Like if I don't have a pet, if I ever got one, I'd probably use Chewy. Most likely. I would just – sorry. I would say I trust getting food or pet food from something like this as opposed to on Amazon. There's like a deteriorating trust factor with me on Amazon. Yeah. Well, you just got to be smart with Amazon, but I don't know.

You got to go to like, Amazon, you can't go with one of those random brands. You got to go with, I don't know what the big brands are, but you got to stick with those. It is concerning. They have some problems with the, I don't know, bad, uh, it's not customer service. It's just bad. Uh, the inventory isn't high quality. Um, let's see any anecdotal elements for me. I haven't used it, but auto ship seems like they really got that right.

Uh, it seems like an easy service. Like you just, whatever, 5% off and you schedule it. But Amazon's is a pretty bad scheduling service. I used it for a few food items and you can't get it down to enough where it's either coming too fast or too slow. So Chewy, I don't know what they're doing with it, but it seems to be working incredibly well with 70 percent or was it 69 percent of their revenue coming from auto ship stuff. I mean, that's just really impressive anecdotally. All right. Future growth opportunities, Brad, what do you have for us? Yeah, mine's pretty straightforward. So thinking about macro demographics, the younger the generation, in general, generally speaking, the higher propensity is to spend on pet supplies. So we're talking about these crazy meal prep plans that are coming out in organic food lines that people are spending on. And that's because our generation and millennials and the younger you get, the more we have proven to be willing to splurge on our pets as we consider them family more so than older generations do.

And I guess we love them a little bit more than older generations do, again, generally speaking. So I think ARPU average revenue per user has a very long way to go just because they are a core brand in this movement. and they're just going to be able to ride this wave of more and more spending as younger people become a larger portion of pet ownership. Yeah, that makes sense in the light of management said that if customers get to their fifth year, they're spending, I think, $800 with Chewy. So that, to me, tells me that ARPU, or however they define it, should just continue to climb over time. And I forget where I saw this, but percentage of homes with a pet has gone up dramatically over recent decades uh and it's been something that's steadily increased so

i think brad's right uh i think younger and younger generations continue to see them more as like a part of the family yeah i'll get into mine so future growth opportunity for me is their proprietary brand so this is i put it as the amazon basics for chewy it's currently outpacing the growth of the overall business and it if you're looking it's in they put it in the other category it's very hard to see where they classify that but it is in the other one i had to look it up for a full article i was doing uh so other it has the health care stuff in there too but other for some reason they're putting like their their basics in there too okay and so that also is higher margin they didn't explicitly say that but it has to be maybe they did say that but it's their gross

margin over of the overall business ticked up because of uh proprietary brand growth outpacing uh top line traditional growth and then i'd also say they're discounting their in-house brands in-house brands pretty heavily so based on the website it looked like it was much cheaper than a lot of the other dog foods and get them on auto ship that's three you know like four years straight. I mean, people, you know, they're not, they're keeping that the same, you know, typically. Yeah. Yeah. There, I won't get into why, but there's a reason that you want to keep your pet's food the same. So once you start using one, you kind of stick with it. So given a heavy discount on that first time, if for any dog owners, you probably know, I'm not going to give

the reason why Ryan, I'm not going to, I'm not going to digest it. Yeah. But so I think that early discounts a great way to get them on board and kind of grow that proprietary brand yeah all get into mine it's the health stuff it's called chewy health and then they also have this new initiative called connect with a vet um and that means veterinarian not like veteran uh it expanded into its online vet offerings and they started this in may so they added video consult consultations pre-schedules and then extended hours of operation where you can go upwards to like 11 at night which is just another way they try to focus on having the best value proposition for pet owners. Because sometimes, you know, your pet could be in trouble. You could be worried about it. You

don't want to wait until, you know, the nine to five opens. This is probably a tough market to go after. There's a lot of moving parts. Seems like there could be some regulations, but I think it could help accelerate the core business. Because if you're consulting with a veterinarian who is a partner with Chewy, I think there's no doubt that they're going to recommend Chewy products for the patients. It kind of locks in more with this ecosystem. Or at least refer them to the pharmacy. Yeah, or refer them to something where Chewy is going to get more, you know, they're going to get helped out more. And it makes it different than a traditional retailer. Amazon

will not be doing this i don't i doubt okay i guess i doubt amazon or walmart or costco or target would do this and it makes it so they have a clear different value i guess i'll just say value proposition again versus just a standard retailer yeah and the other the only thing i'd caveat that with is so petco has a huge kind of global footprint and i guess that's they could do that That kind of talks to one of my lowlights potentially, but they have a lot of vet offices or they have vet offices, I think in 10% of their storefronts. So that's the other one that could potentially compete on that with them.

But this is obviously a digital offering, so you don't have to leave the home. Yeah, the telehealth thing, it's tough, but we'll see. All right. Highlights and lowlights, Brad, what do you like? What do you don't like about Chewy? I think the branding is phenomenal. So ordering pet supplies from a place called Chewy just feels right to me. And so I think that's a pretty strong factor with this investment. And then pairing that with this other feature of them being effectively obsessed with customer

service and coming up with really innovative ways to ensure that that customer service remains elevated that we've covered a little bit, it's a pretty darn compelling combination to me. And then pairing that with the fact that their balance sheet is so pristine and they're already profitable and there's very little stock-based compensation compared to some of these other companies that we look at, they, they can be very aggressive, um, in pursuing growth, maybe things like a pet metaverse, which I'm completely kidding. Yeah. Yeah. The petaverse the, uh, yeah. You've been listening to the Zucks and Microsoft, you know, the conference calls too

much, right? Yeah. And I'm listening to Zuckerberg talk too much, but, but low lights, this might not be fair to them, but it's my low light anyway. So, uh, it's, it's honestly Ryan Cohen in the board member um who is the ceo of pet smart and he's a board member at chewy and he's a board member at gamestop so i i just i find that company and i'm sorry if this offends anyone just so darn toxic and so stay away from it at all costs that any involvement with it just makes me cringe a little bit and it's not a red flag it's a yellow flag and there's not a whole lot of other things to pick at with this company but i didn't really like seeing that yeah he's not controlling chewy anymore so it should be fine but like you know he's a bit of a wild card it looks like ryan

cohen's unaffiliated with him yeah more so this this current board of directors who is the ceo of pet smart and is still a board of directors on chewy and gamestop so that that's the connection that makes me cringe a little bit more um i'm not going to fault them for a founder selling out and and wanting to do something else but i forget his name but the ceo of pet smart being involved with Chewy and GameStop directly. It's just, it's just a little bit unsettling for me. Yeah, yeah, for sure. Highlights for me, it's a pretty resilient business model. There's not a whole lot of seasonality or cyclicality. If there's a downturn, pet spending should not, I mean, it's new pets, new pets. I mean, once you have them, you know, if the economy is going down,

and less people are going to be getting new pets. Yes, but the spend on food, I would say, is a necessity. They highlight that in their 10K as well. I mean, it's kind of, you know, it's just one of those. It's not really discretionary if you have an existing pet. I guess the other thing would be habits rarely change with pet spend. so if you can lock in a lot of customers i i think they're going to be around for a long time i also think the sending flowers when a pet dies is brilliant i at least anecdotally people that

have pets pass away tend to get another one and it's probably hard to go to a different pet supplier uh after something like that when they you could see that would be nice about it yeah you can see people being judgy about it too like oh use amazon wow i take care of my pet i use chewy yeah i guess there is that um and then low lights for me there really isn't a lot i guess petco is a pretty viable competitor they have a really large footprint it kind of feels like amazon slash walmart dynamics you could argue like the tan you know like kind of like tan maybe i don't know it's tough though it's tough to put tan as a low light yeah i wouldn't even it's possible it just might stay fairly fragmented consumer habits obviously it looks like chewy's

been able to eat market share for a while maybe they went maybe they had just i don't see why that would stop yeah well they could have gone after the easy customers it could be harder to attract the future customers um but that's i don't know that's i don't know i have no reason i'm kind of reaching for low lights i'll say that yeah same with me um highlights though strangely it reminds me of peloton that's kind of the company i thought of here people would be like some people might roll their eyes here but just the way they take care of their customer base and making something that should be a commodity more of a uh i don't even know how to describe it like more fun yeah or the what do they call it brand affinity i guess i don't think

Chewy has the brand affinity of a Peloton because they're one of the top in the market. But yeah, pet market though is a perfect, I think, you know, niche. It's not really a niche if it's a hundred billion dollar business, but the big boys like Walmart, Amazon, and Costco are not going to focus all of their resources on it, but it's still big enough where someone can, you know, win and take a lot of market or sorry, get a lot of annual revenue. yeah it's definitely not worth some sort of massive investment from the big guys because the reward just isn't there but it's yeah it's kind of like that perfect middle ground yep and then without any hard numbers i mean we talked about it customer attention has got to be pretty

strong with a business like this you can just see it i hate to describe it like that but you can kind of just from the way the business is the anecdotes you see how they have auto ship is such a high percentage of revenue customer attention has got to be really good with them Low lights. Margin is the only one for me. Yeah, low margin business. They're already 10% market share or no. Going to be close if they hit their numbers this year. That's a concern for me. I wonder how much cash they're able to generate. But other than that, really hard to find low lights. I mean, their strategy has been bulletproof, I'd say. Do you guys have any problems with any of their strategy? It's just like, I don't know, the path for them is pretty clear. It's just been an efficient e-commerce business that does one thing really well. I mean, I guess they have these other initiatives, but they're not reinventing any sort of strategy here. They're just doing something exceptionally well.

Yeah. Brad, did you have any problems or any concerns on that? No, and I also was really reaching for low lights because there's not a lot to pick at. But in terms of the low margin for a business like this, I always think it feeds into your thesis of the big boys not being too focused on taking their market share and trying to eliminate them because it's not as lucrative of an opportunity as AWS was or other things like that. So the low margins, as weird as this sounds, almost insulates them from new competitive entrants. And it infilates them from startups because startups have to get to scale before it can work. Great point. And I mean, if they can scale largely enough on the top line, then you can make a really nice business out of 10% run rate profit margins. Yeah. And they have what, 12 fulfillment centers? I don't know if Ryan, you mentioned the specific number, but that costs a lot of money to build out. All right. Bold case, Brad, what do you think has to happen for Chewy to be a good investment going forward?

yeah so it's it's not going to be a verb but sort of like to venmo is associated with sending money to order from chewy is associated with ordering pet supplies so it achieves ubiquity across the world and successfully expands into other territories um it becomes a leader in scale so that it can profitably undercut and profitably um accept these lower margins to insulate itself from that competition and build market share sort of using a predatory pricing model that walmart did so effectively for so long um that that seems like the bull case and it seems pretty darn feasible at this point all right that makes sense ryan yeah uh the now i usually take these estimates with a grain of salt but the category is expended expected to compound spend at around

five to six percent so if that happens uh that's right every category is going to grow faster than gdp but this has because more homes are beginning to own pets uh so i guess if that persists and then if chewy continues to eat more and more market share of that pet spend i could see the core business so as long as they just mildly outpace the category growth um and then they the core business reaches 10 free cash flow margins and these other initiatives uh are kind of like call options on the business and they work out there's a bull case here for outperformance i i don't see this being a 300 billion dollar business just because like brett said there's some sort of tam limitations there uh but unless they go really they get really successful

internationally which is a big if yeah and i guess they said they could go international but it's purely us right now yeah they said they're and i do like this not going international just for the sake of international uh they're saying they're targeting to try to do that within the next five years but right now they see just the opportunity within uh the u.s that they want to get that perfect before moving anywhere else yeah what about you um similar to you guys i just slapped some numbers on them i think you probably need to see 50 billion dollars in annual sales on like 10 profit margins. That's doable, but tough. Just giving some customer numbers around that, that would mean 50 million customers spending $1,000 a year. And if you don't think that each customer

is going to spend $1,000 a year, you have to think that they're going to get more customers. So it could be 100 million customers at $500 a year. That doesn't seem crazy, but it's pretty far away from from here and i don't know if there's 50 million customers in the u.s unless they get a hundred percent market share because not everyone has pets and you know it's family spend like brad said there's not four people in the household using chewy it's just one household so you know the i guess that whole case kind of turned into my bear case a little bit of the tan stuff too yeah a lot of customers they got to get uh all right wrap things up with the bear case Brad, what could go wrong here?

Yeah, I want to preface this with saying I don't think it will happen, and I'm reaching for a bear case like I did with Lowlights, but they could get Amazon, and I own GoodRx and Teladoc, and I owned FedEx for a very long time. So I think the threat of somebody like Amazon entering a competitive field is often overstated if a company is effectively run and has a compelling value proposition. I don't think it's the end of the world, but more so proof of concept.

But if Amazon comes in and can do to Chewy what it has done to other companies in the past, that is the bear case. Yeah. It seems unlikely. It seems unlikely, but yeah. You mentioned that. Right. For me, I don't know. There really isn't a crazy bear case.

There's not like a short case. There's not like a short. You couldn't really write a short report out. The business model has been proven at this point. they have a loyal customer base and spend is growing incrementally each year it to me the bear case would be that they mildly outpace category growth and then these other bets don't really prove out to be anything and then at that point you kind of have something that's just slightly underperforming the market maybe not a great investment it the the downside is pretty

limited here yeah the worry is just that you're not the worry is that the stock stays at their 40 50 billion dollar market cap forever that would that's kind of what i get concerned on and like when i i don't know why but when i i read about this business i just go and like that's that's my immediate thought i'm like why would i invest in this over other things but maybe that's what cause so many people to overlook it because when they IPO'd I bet when Ryan and I were talking about it if we were ever just chatting about it like oh did you see Chewy IPO and we probably would say like ha what's that another pets.com we're about to pop the bubble like yeah but it's actually a lot different I think a lot of people don't look at the underlying business but I think

the bear case just margins that's it could hold them back I mean you got one category or not one category excuse me you have a limited tam at least in the u.s margins are not great i mean how much cash can they reasonably generate to say that it's worth you know 75 100 billion dollars that's where i find trouble here and i think we're kind of that's similar to what both you guys said as well um all right more or less interested brad um yeah i i think i gotta go with more interested uh not there are no red flags here in my opinion just just yellow flags uh so i i do think that it's not it's not crazy expensive like some of these other companies we've covered but um i don't know there's nothing that that makes me say now i don't want to own it but there's

yeah i don't know more interested not passionately more interested and then then just one more note i'll add if people are thinking well the tam is not an issue because they're just going to expand into europe and asia and all these places and they'll be fine just an anecdotal um comparison to a logistics-based company like fedex i'll use that example again when they bought tnt in europe it took them years and years and years to profitably integrate those assets so it's not a given that they can just expand everywhere um maybe that is my maybe that is my bear case but But I am more interested, and I'll keep watching it going forward. And American consumer and pet culture is, I believe, a lot different than around the world,

where I guess what I'm trying to say is, like, in Europe and other places, there's less propensity to accept, like, a Walmart or a Costco or just kind of the big brand, you know what I mean? if you guys can't get what i'm saying so back it's up but i mean people have had success before you know mcdonald's is everywhere i guess for um yeah for me there were no red flags it seems like a sound business it seems like it's been proven and i could see it continuing to grow but it's just unexciting like i i for some reason i'm still less interested um the upside just feels capped i'm in the same boat yeah yeah i'm in the same boat i don't think i have to say anything else yeah less interested nothing wrong hi i think it's a quality business uh but i'm still

less interested and maybe that's why the opportunity has been so strong brad so in a hypothetical world if this if these fundamentals existed and you were reading this s1 and it was going public today at like a $10 or $15 billion valuation, would that open your eyes? So is it the fact that it's too far along in its journey for what it is right now that the risk reward is kind of skewed a little underwhelmingly? Yeah, they've proven it. And I wonder what the financials looked like at the IPO, because if it hadn't proven any cash generation, I would be worried. I would be worried. And I don't know if I would have been able to take that risk. I don't know, Ryan, do you have any?

Yeah, I mean, if the valuation were cut in half, then yeah, I'd obviously be more interested, but yeah. If I Roku, if it was cut in half, we'd buy Snowflake. Yeah, everything, everything we talked about. I mean, the valuation isn't like dirt cheap, I'd say it's fair. Like I said, it is, I guess, Tam worries.

Yeah, all right. Well, I think that's gonna wrap things up. stock for next week. Yeah, my choice. We're going to stay in the, I don't know, I don't know if people are going to be excited or disappointed with this. We're going to stay in the high valuation software. We're going to do Doximity. I believe they just went public. Recommendation. Recommendation from a listener or watcher on YouTube. I cannot remember exactly where, but should be fun. I've seen that thrown around a bit. So yeah, watch out for that next week. All right. Before we wrap up, remember that none of us are financial advisors.

Anything we say on this show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next week. this family is on the brink of civil war on september 18th mobland the hit original series is back on paramount plus we are the harrigans don't know the net and google us from the underworld of guy ritchie do you want to step up the ladder i want karma dead starring tom hardy pierce brosnan and helen mirren do i have to do everything myself mobland new season hits september 18th on paramount plus

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