Motley Fool Hidden Gems Investing - Chewy Fetches Growth

Episode Date: March 26, 2025

A discount retailer sheds some branches; a pet supply store picks up a few extra treats. (00:21) Tim Beyers and Mary Long discuss the difference in dollar stores and Chewy’s latest earnings. Then, (16:36), Tom Gardner and Andy Cross talk with Sezzle CEO Charlie Youakim for a closer look at the uniquely positioned buy-now-pay-later company. Companies discussed: DLTR, DG, WMT, CHWY, SZL Host: Mary Long Guest: Tim Beyers, Tom Gardner, Andy Cross, Charlie Youakim Producer: Ricky Mulvey Engineers: Dan Boyd, Heather Horton Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. The Dollar Tree gets a trim. You're listening to Motley for Money. I'm Mary Long, joined on this fine Wednesday morning by a Mr. Tim Byers. We are live and in a kind of studio in Denver, Colorado. Tim, great to see you. How are you doing? Doing well, Mary? Fully caffeinated, ready to go? As am I. Refilled my coffee right before we walked in here. We'll kick off this morning with a story about a family of dollars.

Once upon a time in the year 2015, the Dollar Tree bought the family dollar chain for $9 billion. Today, about 10 years later, the Dollar Tree is selling that family dollar chain for $1 billion. It's going to a duo of private equity companies. tim solve this for us why couldn't family dollar find its place within the dollar tree family tree i mean i think they're different businesses to be honest the price for the deal is isn't necessarily awesome i i do know that but i'm not sure it's actually bad because if the if it doesn't fit then it doesn't fit and you have to figure out how to make the business work on its own. And to be fair, the current Dollar Tree management has been figuring this out for quite

some time. I mean, when they bought Family Dollar, they really piled up quite a lot of debt. And they have ever since been lowering their costs, figuring out how to optimize merchandising, figuring out pricing and so forth. And so it has gotten a bit better. Now, I have heard from our colleague Buck Hartzell about this, and he's done a lot more work on this than I have. And I think he's right in that removing kind of this anchor from Dollar Tree might unleash them. Because even if it's only a billion dollars, if you can take that billion dollars and use it to pay off even more debt and get Dollar Tree a bit unlocked, a bit more unleashed, we might see a much different and much more valuable Dollar Tree in the market. So I'm a bit more optimistic about this. I mean,

remember, over the last year, about a billion and a half dollars of free cash flow, and they've paid down about $3 billion in debt over just the past year. So this is a business that's getting better. If it's a little bit lighter, well, maybe it starts flying. You talk about unleashing the potential of Dollar Tree, and it seems if we zoom out and kind of look at the macro situation that we're in, we have some new data that came out earlier this week, earlier this month. The Consumer Confidence Index, for instance, came out earlier this week, and it indicated that, okay, the economic outlook among a lot of Americans is at its lowest point in the past 12 years. You've got reports of U.S. retail sales from February that came out earlier this month, and they were lower

than expected. So we haven't seen a full pullback. Sales rose, but only by 0.2%. So with that in mind, one could be forgiven for assuming that, okay, this is actually a time for discount retailers to be unleashed, to potentially fly. Market's tight. People are tightening up their wallets. They might be more apt to turn to these discount retailers. But that doesn't really seem to be what we're seeing unfold quite yet for Dollar Tree or Dollar General? The former operated at a loss in 2023 and has negative net income for the trailing 12 months. The latter still posting a profit, but it has shrinking margins. Why aren't we seeing boom times for these dollar-branded retailers quite yet? I mean, that's probably tougher to say. And I think some of that may

have to do with you know these just like every retailer they do have some classic audiences like you are and i don't think you're wrong to do this you know there is maybe a class of consumers that typically has not shopped at a dollar you know a dollar store market and when things get tighter, would they choose to try a dollar market? Maybe, or maybe not. It is also possible that the core audience for these deep discount retailers are just getting squeezed because, frankly, everybody's getting squeezed. And even with these dollar stores, you have to think that some of the merchandising has changed. The pricing has changed. Your dollar is not going as far as the dollar used to go. This is something that we heard probably about a year ago. It

was all talk about shrinkflation. The packaging is changing. Your dollar isn't going as far. buy a bag of potato chips, and you thought for $1.25, you were getting a 15-ounce bag of potato chips, and now you only get 12 ounces. Shrinkflation. I do think that it's not as simple. Yes, there is an argument that this is a time for dollar stores, but I think those dollar stores have to convince maybe a new audience to give them a shot. I think we're pretty early in the cycle for that. They have to convince a new audience to give them a shot, but also they have to compete against not just other dollar store type stores, but other discount retailers. So Walmart, for instance, is crushing it. In the past year, Walmart's stock price has

increased by nearly 41%. Compare that to shares of Dollar Tree and Dollar General, both of which have lost over 43% of their value in the same timeframe. Why is there such a stark divide between the performance of these two admittedly different types of discount stores. Yeah. Scale matters. I mean, it always has. But in the case of Walmart, they're not unique, but they're pretty close to unique in the amount of power that they can exert over a supply chain. They're not just omnipresent around the United States and in different parts of the world, but their ability to command pricing power in all of the supply chains where they buy, because they buy in such bulk, such magnitude, that Walmart is just different. They're different

scale. They have an extraordinary amount of power in that respect. They are also one of the greatest users of data and logistics in the world, really. So they have done more to build out an infrastructure that gives them real margin power. And it's just cooked straight into the business, Mary. And it's always been this way. And I think they're trying to widen their lead here. And times like this, where economically, see, I do think there is a difference. And I feel like I'm being a little bit unfair, but I don't know that I'm wrong. I do think there is a difference between maybe downgrading your shopping from your local grocery store to Walmart and getting a little bit of a price break there. I don't think that has any stigma. If you're going from your grocery store

to Dollar Tree and you're not used to doing that, I don't know that you're willing to make that leap. I do think that is different. Also, the Dollar Tree, to be fair, is not going to have the same scale to serve, let's say, your grocery needs. It's going to serve maybe some novelty needs and some of your grocery needs, but Walmart can essentially serve everything you want and at a potentially much lower price. They're all discount retailers, but there's a lot more that you can get at a Walmart that you could not find at a Dollar Tree, Dollar Store, or Family Dollar. We'll move on to another story. Chewy, the pet supply retailer, posted fourth quarter earnings this morning. Tim, I've been in a coworking space with you long enough. I know

you love pets. I know you love dogs. Love me some dogs. Yep. So let's figure out how you feel about this stock. One closely watched metric for Chewy is its customer count. So they added over 430,000 active net customers over the course of the year. the increased net sales per active customer. Immediately post-pandemic, though, Chewy was experiencing some slowing customer growth. So what happened to kind of turn that trend around? What did they do? I mean, it's hard to say exactly what happened here, but it does appear that Chewy is doing a lot to do more for its customers. You know, in tech, we hear this term a lot, but it's called WalletShare. We are getting more from our customers by doing more

for our customers. I'll talk a little bit more about this in a minute, but as a provider that you can go back to reliably over and over and over again, the evidence is that customers are relying on Chewy more and more and more. The auto ship, for example, that has been an unqualified success i mean my goodness you know you sign up for chewy and then every month you get a certain amount of deliveries on a prescribed schedule for your your little furry friend and that can include things like medicine it can include food it can include toys all of this stuff but auto ship sales were up more than 21 and overall sales were up about 15 so the fact that auto ship is growing as a portion of overall sales. It's just so good for the business. It's really good for

cash flow. So overall, Autoship is now 80.6% of all sales. That's up from 76.4%. That is astoundingly good, Mary. It just means that the relationships with customers are getting deeper. And this is what we need. As investors, we really need Chewy to convince its existing customers to do more with it needs them to stay need them to grow their relationship and then choose to new do other things with uh chewy over time so that does seem to be happening i find that very encouraging uh the key question is with a lot of economic uncertainty right now is it going to continue to be this way i think it's very encouraging that in the fourth quarter chewy was able to achieve what they were able to achieve more net customers more spend right now we are

entering a very weird economic period. So this quarter, I think will be an interesting bell weather. So you talk about like growing and deepening the relationship with the customer. And this is something that's relevant for many businesses, but I feel as though it's really relevant whenever we have a conversation about Chewy. I hear it when I listen to investment analysis about this company, or just when you talk to customers and consumers about this company, people really hit home this loyalty point about how much customers love Chewy. Okay, that is great, but it costs money and time to create, to nurture, and to keep that customer loyalty. And there are plenty of companies that build that up and then break that. I'll shout out

my once beloved Southwest as having broken a brand promise in favor of improving and increasing their top and bottom lines. How does Chewy balance its commitment to customer care, which their CEO is very explicit about, while also prioritizing growth and finances? Yeah, it's a tough one. You have to figure out how to... This is the optionality argument that you've heard me make before. You have to provide more things that are of obvious value to the customer. They're not just going to stay because they like you. You have to provide value. And in this particular case, I do find it very encouraging that Chewy has had some success with their vet care clinics. You know, they opened eight in the last fiscal year. They plan to open another eight

to 10 in the coming fiscal year. And they seem to be doing quite well, Mary. I mean, they seem to be providing a place for a Chewy customer to go and do all the things you would do with Chewy. You could get some food, you can get some toys, but you could also get, you know, your take your friend in for boarding. You could take them in for getting medications and shots and all of these other things that are very important. And that's, it does seem to be creating a touch point for Chewy customers that leads them to engage more deeply. I find that super interesting. I hope it continues to be this way. It's too early to say whether or not this is exactly a good comparison, but what it appears to be just based on the nest pack customers, the net,

you know, spend per active customer that was up what 21% year over year, really good numbers there. it seems to have a little bit of a warby parker feel to it and i'll tell you that was the thing that really unlocked warby parker when they started going to stores and you could come in and you can get your eye appointment done you could get your you know your tests done and you could get a fairly affordable pair of glasses and use your fsa spend for it if you're handling more of the overall need for the customer, that seems to go very, very well. It's been a real boon for Warby Parker. It seems to be happening for Chewy, but I think it's just a little bit too early to tell, but that seems to be the indicator here. Those vet care clinics

seem to be a catalyst that's driving this company forward, and I'm here for it. A comparison between Warby Parker and Chewy was not necessarily on my bingo card for our conversation today. Anything else you want to add before we wrap up about this quarter or the year for Chewy? Well, I think it's nice to see that the economics of Chewy are starting to work out in their favor. Because one of the real worries, and you made this point before, is that the active customer count was declining, and it looked like they were going to be subject to some real headwinds in terms of the economic climate. And that as a premium product, it was going to be easy to disconnect from Chewy. It's encouraging that that's not happening. And what seems to me,

Mary, the thesis now is that by virtue of handling more of the overall pet care, you know, the life cycle of pet care, everything from vet to medication, to food, to toys, to all of those things, it seems that they are sucking up more. They're getting more dollars by solving more of the problems. And if that's true, and if it continues down this path, I think we're in for some very good returns for this stock. But it's still early. I will qualify this by saying, let's see how these vet care clinics continue to do over the next several quarters, but so far, so good. Tim Byers, always a pleasure. Thanks for coming on to the show today. Thanks, Mary.

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Andy Cross, plus our CEO and co-founder, Tom Gardner, interview Charlie Uakim, Sezzle's CEO. well charlie we're excited to have the conversation with you talk all things sezzle which is a really exciting it's a recommendation of ours so we're excited to get right into it and just talk a little bit maybe about the buy now pay later company you founded can you explain what sezzle does for our members and really why is it different in a very competitive of buy now, pay later space? Yeah. One quick way to describe it, even to my mom, when we first started the company was think of like reverse layaway, you know, basically in the old days with layaway, you'd make a purchase, but you'd have to wait for the product. Buy now, pay later

is an innovation upon that, where it's basically, I call it reverse layaway because you make the purchase, you get the product upfront, but the payment plan still exists paying for. So it's four payments, interest-free, over a six-week time period. So 25% down today, two weeks, four weeks, six weeks. And we automate the payment plan for the customer. And the reason it became very, very popular in a short period of time was it really made a massive difference for the merchant in terms of driving conversions, driving sales, increasing basket sizes, and just changing decision-making for the customer. And our customer tends to be like a mid to low-income, younger customer. And I think what was going through their mindset when they're making this purchase

decision was, I can budget for that product. I'll come back later. And I don't want to use my credit card. 65% of our customers have a credit card, but they just choose to pay us with debit cards. They don't like to use the credit card. And so they say, I'll come back and buy it later. But merchants know that the customer is not going to come back. So we change the buying behavior by basically putting the budgeting tool on the website and telling the customer about it that you can pay in for for this over six weeks and you know a lot of these customers get paid bi-weekly and so the customers felt very comfortable that i could basically budget for this make the decision to buy it now and they also felt comfortable with the credit

product in that there was never a chance for like a credit card to create a burden in the future or some sort of stress where now i maybe i overspent a little bit and i can't pay that off in full next month. And now I've got this balance that I got to pay interest rate on. So I think that's what the aha was on the consumer side and on the merchant side. And that's why we've had this just dramatic growth in our sector and with Sezzle as well. I want to reset one more time just to help our members understand the three primary players here at a transaction. So maybe take a classic case study of who is it, who's your sort of classic customer, what are they actually buying? And then what's Sezzle's part? What's the merchant's

part? And what's the, and what's the customer's part? Even, even though you've done a good job already with it, I think just getting to walking us through one transaction would help. When we first started the business, what we would do is we go to retailers and we tell retailers, put Sezzle on your, your site as in the checkout, much like PayPal, you know, put us in the checkout, put us on your product page though. That was actually one of the most important keys. Put us on your product page. And when you're selling a product, and our typical products early days, the key price points are $100 to $200. So I always give an example of a pair of jeans, or you're buying a sweater. Fashion and apparel, beauty and cosmetics were the core at the start. So you're buying a pair

of jeans for $100. On the site, it would say, or interest-free payments of $25 with Sezzle. And you could click on that little advertisement widget and find out more. Because early days, it seemed like it was too good to be true for the customer. So they had to learn more about, you know this is real and then what would happen is okay and then in that transaction the merchant would pay us like a six percent plus 30 cents but that was our rack rate of our product blended average right now is more like five percent because we have larger merchants in the mix so they pay us like we're a processor the retailer so the customer decides i want to buy that pair of jeans they go to the checkout they choose sezzle they sign up with us we make the payment

plan for that customer and fulfill the purchase. We pay the retailer the $100 minus the 5% blended average we have. So less the $5. So the retailer gets $95. They're happy. I got $95. It's two more dollars than I would have made or two less than I would have made if I would have processed with Stripe. But I still got $95 and made a sale. They've got margins that are like 60% margin, and so they're happy. So they make the sale, they ship the product, customer gets the product, and then they now have a Sezzle account and they make the payments to Sezzle automated. It's all automated. They don't have to think about it. And those payments come into Sezzle over that six week period. And that's basically the interplay between customer, retailer,

and Sezzle. Original model. What Sezzle has done that has really made us attractive as a company, I think to investors and just as a growth company now is we've continued to innovate. I'm an entrepreneur. I'm a believer in innovation. And the innovation that we launched, or the innovations, was more of a direct-to-consumer model. We have now two subscription levels and a pay-as-you-go product that allows the customer... Originally, they were kind of locked into our network of 25,000 merchants. They could shop at all those merchants in our app. We launched Premium in 2022, which allowed the customer to shop at 300 top merchants in the United States through our app.

if they paid us $12.95 per month. And that unlocked a lot of places to shop that the merchants or the customers were asking for. And so now there's less of a relationship with the merchant, or at least less of a direct relationship with the merchant. They'd still go shop, the customer would shop at the merchant, we'd finance it, we'd pay the merchant through interchange, through like either a gift card or through a credit card,

we'd pay the merchant, they'd get their funding. But then the customer would just pay us back directly. And then we launched Anywhere the next year, which allowed the customer to get a virtual card and just shop anywhere for $17.95 per month. And then this year, or this past year, just a few months ago, we launched something called On Demand,

which didn't require a subscription. You could just basically pay a service fee, almost like an ATM fee, $4 every time you shop. When you make a transaction, you just pay $4 and we'll transact. No reason to get into a subscription. So that's basically like the interplay right now between Sezzle, merchants, and consumers.

There's a financing arm to this that you partner with various firms, like WebBank, for example, that fund the ability for you to be able to pay the retailer. And then you pay a rate on that. Oh, absolutely. Yeah. So WebBank is our banking as a service partner. They enable our on-demand product because it's a finance charge, essentially. So that's where WebBank plays into it. This is a partner. And we just launched them in October of last year, late September. But you're right. We also, we lend to the customer, essentially, we borrow from a group called Bastion. They've worked with us for the last six years and they lend to us at SOFR plus six and a quarter or so, somewhere in that

range. And that's our funding facility through to the customer. That's a unique proposition in the buy now, pay later space. And I just want to make sure our members understand kind of, so the, you know, an average monthly rate, maybe of $15 or something, the 15 to $16. And you're talking about, you know, hundreds of thousands of people who now who are subscribing to the Sezzle subscription offerings. And I just want to make sure we, cause that's a lot, that is different than what you see from some of the other buy now pay later providers. Yeah. Most of the other buy now pay later providers are really focused on the merchant relationship, which was the original model. And I think if you look at Sezzle right now, we're the most complete. So there's one of

our competitors, Zip, has what we call on-demand. We saw them launch it. We liked it. We knew we wanted it. We needed it. But we're, I think, the only player that has a very strong subscription offering, from what I can see, at least. I know Afterpay launched one, and they no longer have it. I don't know why. Klarna has one, but it doesn't seem to be a large percentage of their business like ours is. I don't know why again. It's basically Sezzle with this subscription offering that seems to be, I mean, it definitely is an important part of our business. So we're definitely unique in that regard. And I think part of the reason why it's such a good product for the customer is, you know, like all of us, we're, you know, we have this like heuristic or

lazy, natural human laziness. When you're signed up for a subscription, you don't have to think about when you're going to a site, which one of these am I going to use? You just use Sezzle and that's worth the $15 a month. I don't have to think about it. I just use Sezzle. I don't have to look at the checkout, who's there. I just use Sezzle. So I think it's solved that kind of pain point for the customer. I'm not a financing lending expert. I did talk to somebody who spends a lot of time studying buy now, pay later companies. And their primary question was, what happens as the model scales and sourcing the capital to cover the X number of weeks that you are waiting to get the payment back from the customer? What happens if this company is five

times larger? How do you see the pathway to making all the partnerships work and the financing arrangements work, including in different macroeconomic environments to the extent that that has an impact on your model? Yeah, great question, Tom. I mean, I think that's, I believe in scaling big time when I'm building a company. That's what makes a company attractive, its ability to scale. So a couple of years back when we were going through this reinventing of the company and getting to profitability and continue to push forward we told investors watch us we are going to show you how well this company scales and i know i knew it scaled i'll tell you like early example when we first launched we had our first holiday season we probably like six people

in the company this is like 2017 2017 the first holiday season six people in the company the thing just ran automated over the holiday season like no one's in the office you know it's so like intrinsically i knew this scales incredibly well like i mean it was not a massive holiday season compared to what we have today but it was like it's software it's just running you know so i it's we knew it scaled and so i said to investors a couple years back and we keep on saying this because it's my favorite chart we always talk about it um if look at our operational expenses versus our gross margin dollars and we're going to show you how we can have a different angle of inclination on those two lines and show you how well it scales because we don't need to

grow OpEx, to grow revenue and grow gross margin dollars. And then in terms of the funding mechanism, because people have a question about that, the beauty of BNPL is it's very funding light. Personally, I don't want to go longer term with the company. I don't like it because you create a really heavy cash burden. Driving cash flow in a business is important to the valuation of the business. And when you have a long-term financing activity, there's a lot of cash demand. With our product, it's essentially a three-week product because we take 25% at point of sale. And then the last payment is at six weeks. So put the teeter-totter on it. It's a three-week product. Our last couple of quarters, our draw on our line was $90 million and like $105

I think the last of this quarter. And if you think about that, we're doing over $2 billion in terms of run rate and processing, but we're only borrowing $100 million to do it. That's because of all that turnover. And then one of the really unique things, and it doesn't take a very complicated spreadsheet to see this, with our growth rates and our gross margin percentages, eventually you can drive enough cash into the business where, in theory, if you keep these sort of at a steady state, you don't need a line of credit. You can scale off the line of credit. I'm not saying it's the best decision, but that's attractive that you have the option to if you want to, which I think makes you very resilient in potentially a very bad economy, that you may not

even have that much of a dependence on a line of credit at all. So I think that's one of the nice things. And then in terms of just resilience in economic downturns, that's why we shoot for a 55 to 60% gross margin. Because the thing that's going to move the most in an economic recession or a very bad one, let's say, is principal loss rate. No doubt about it. But we've got basically is 6% on dollars, on the GMV, 6% NTM or gross margin percentage. That's a huge cushion for principal loss rates rising. Maybe we go from a 55% gross margin percentage down to a 35% and some sort of maelstrom, but we still have a 35% gross margin percentage. We've got a good barrier. As always, people on the program may have interests in the stocks they talk about

and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. With The Motley Fool Money Team, I'm Mary Long. Thanks for listening. We'll see you tomorrow.