Top Picks 2020: Chewy (CHWY)

01/06/2020 5:00 am EST

Focus: CONSUMER

Hilary Kramer

Editor, GameChangers

Chewy (CHWY) — my top pick for aggressive investing — is a pet food phenomenon, suggests growth stock expert Hilary Kramer, editor of the specialty advisory service, IPO Edge.

My channel checks in many U.S. cities reveal box after box delivered in affluent neighborhoods, sometimes on every doorstep.

I've been a fan of the company since its June IPO but at the time the drag on the stock was simply too intense to reward anything but a long-term mentality.

After all, while CHWY only priced at $22, only early stage investors and the lucky were able to get in below $35 on the first day. Those who chased the hot deal from there might have bought in above $40.

All of those investors have had to suffer through six months of selling and ridicule. Some of them had to hang on through as much as a 45 percent paper loss and are still deep underwater today.

We weren't them. Once I saw the way the wind of sentiment was blowing, we kept our powder dry and waited for CHWY to print a clear bottom. I think it's here now.

For one thing, the lock-up period keeping insiders from selling has now expired as of today. They're not dumping their company stock at this level. They're evidently holding on for better days ahead.

I agree. After all, quarterly performance remains solid. The company is automatically shipping $865 million a quarter in pet food and other subscription-based products, and that end of the business is growing 49 percent a year.

Automated billing is great. When consumers get locked into a habit, it's hard to get them to change. And as long as the account is open, Chewy has an open window to upsell each household to put a little more in those blue-labelled boxes.

Pet medicine is becoming a big deal here. Those prescriptions are relatively expensive, and they need to be administered regularly, sometimes over long periods. This side of the product universe is already profitable for the company and could ultimately boost margins about 5 percentage points.

That's a big deal, theoretically enough to take CHWY to breakeven faster than I hoped. And in that scenario, this is no dot-com flash in the pan, but a sustainable business that can go head to head with Amazon and Walmart in online retail.

After all, it's still expanding fast. Customer growth is tracking above 30 percent a year. All it takes to accelerate that growth rate is a little relief on the margins freeing up cash to pour back into advertising.

CHWY can go as far as management chooses to reach. After that, in the Jeff Bezos model, it's time to consider profitability. Fed fear was also a factor. I didn't want to buy before I saw that Jay Powell wasn't going to break the market's nerve. We're clear there now.

But the last factor that turned this stock into a buy for us has a lot of room to go from here. People who mocked the company bet big against it. A staggering 30 percent of the CHWY float is tied up in short-selling obligations. Those short contracts are unwinding messily now.

They recognize that the stock has gone down as far as it can, at least for the foreseeable future. Remember, insiders aren't dumping. And there's a lot of room left for cautious investors to make money on the upswing.

There's plenty of historical upside left to capture before CHWY even tests its post-IPO peak. We weren't able to get one share of CHWY below $30 back in June. Now we can accumulate up to that price. But as always, don't chase the action. Once you get a taste, feel free to wait for dips.

(Editor's note: In last year’s report Hilary Kramer picked Ultimate Software as her Top Pick for 2019; the company was acquired in May, for a 35% gain.)

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