Markets

3 Reasons Why Chewy Stock Is Out of Favor With the Market

Chewy (NYSE: CHWY), a one-time market darling, is falling out of favor with the market as of late. The stock rose to $120 per share earlier this year and has since almost halved, trading at $63 as of this writing.

The fall from grace can be attributed to several reasons, including but not limited to: rising costs for labor and advertising, reopening economies, and supply shortages. Let's take a closer look at these factors individually to understand why the market is placing such importance on them.

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Image source: Getty Images.

Inflation is circulating throughout the economy

In its second-quarter conference call, management highlighted an imbalance in the supply and demand for labor. As a result, the costs to get people to work for Chewy are rising. The company is making investments (increasing wages and bonuses) to generate applications and onboard enough people to fulfill existing demand for its products. In all, the company spent $30 million, roughly twice as much as it did in the previous quarter.

Moreover, Chewy is an e-commerce retailer of pet products and services; it likely buys online advertising from companies like Alphabet and Facebook. Both of those behemoths reported substantial increases in the price per click and the cost per impression they charge businesses to market on their platforms. In talking about rising advertising rates, Chewy CEO Sumit Singh said, "While this was expected to some degree, the magnitude of the increase in Q2 was unprecedented."

Economic reopening could slow sales growth

Chewy experienced a nice sales boost at the pandemic's onset. As folks were trying to avoid shopping in brick-and-mortar stores to prevent the risk of contracting the novel coronavirus, they spent more money online. In fiscal 2020, Chewy's revenue increased 47% from a year earlier.

Yet in the past few months, millions more people have been vaccinated against COVID-19 and economic reopening has gained momentum. So investors are understandably concerned that the increase in consumer mobility could hurt sales for the online pet retailer. Even if customers don't spend money at another pet store when they go out, they allocate money elsewhere, leaving less income to splurge on their pets.

Supply-chain bottlenecks

It seems like supply-chain bottlenecks abound in all parts of the current economy. Customer demand for products is higher than before the pandemic. Meanwhile, fewer people are willing to work at the prevailing wages with a deadly virus still circulating. That's led to shortages of everything from materials to truck drivers and port workers.

Chewy is experiencing high levels of out-of-stock items its customers usually buy on the site. This is causing it to miss out on sales and potentially lose customers who could be going with another retailer that has procured a supply of the desired product.

Overall, these are significant headwinds, and investors are justified to be concerned about their impacts on Chewy's business. That said, Chewy reiterated its top- and bottom-line outlook for the year when it reported second-quarter results. Further, the challenges, persistent as they may be, are temporary and should ease as world economies emerge from coronavirus-related disruptions.

While a price drop in Chewy's stock was to be expected, a fall from $120 to $63 may be an overshoot.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Parkev Tatevosian owns shares of Alphabet (C shares) and Chewy, Inc. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Chewy, Inc., and Facebook. The Motley Fool has a disclosure policy.

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