Target(NYSE: TGT) and Chewy (NYSE: CHWY) represent two very different ways to invest in the retail sector. Target is one of the largest superstore retailers in America, and about 75% of the U.S. population lives within 10 miles of one of its 1,956 stores. Chewy is an e-tailer that exclusively sells food, drugs, and other products for pets.
Over the past 12 months, Target's stock rose by less than 2% as Chewy's stock plunged 57%. Let's see why the brick-and-mortar giant outperformed the pet-oriented e-tailer by such a wide margin -- and if it's still the better stock to buy right now.
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Target faces a near-term slowdown
Target survived the retail apocalypse by expanding its e-commerce ecosystem with more delivery and pick-up options, turning its stores into fulfillment centers for online orders, and closely matching Amazon's(NASDAQ: AMZN) prices. It continued to open new stores even as other big-box retailers closed down, it opened new smaller-format stores to reach new shoppers in urban areas, and it differentiated itself from its competitors with dozens of private label brands.
Those strategies set Target up for a major growth spurt as consumers stocked up on food, other essentials, and electronic devices during the pandemic. Its comparable store sales (or "comps") rose 19% in fiscal 2020 , which ended in Jan. 2021, and increased 13% in fiscal 2021; yet, only grew 2% in fiscal 2022 as its post-pandemic slowdown was exacerbated by inflation, higher freight costs, and supply chain disruptions.
In fiscal 2023, Target's comps fell 4% as it struggled with slower sales of discretionary products in an inflationary environment, theft and safety issues that led to the closures of several of its smaller format stores, and a boycott from conservative groups in response to some controversial products in its Pride Month Collection.
That marked its first annual decline in comparable store sales in seven years. But as its sales growth cooled off, it cut costs and boosted its EPS by 49% in fiscal 2023.
For fiscal 2024, Target expects its comps to rise 0%-2% as its EPS lands between a 4% decline and 7% growth. Based on the midpoint of those estimates and its current price of $168, it looks reasonably valued at 18 times forward earnings. It also pays a decent forward yield of 2.6%, and it's raised that payout annually for 52 consecutive years.
Chewy's high-growth days might be over
Chewy's revenue surged 47% in fiscal 2020 (which ended in Jan. 2021) and rose 24% in fiscal 2021 as pet owners bought more products online during the pandemic. But its revenue only grew 14% in fiscal 2022 and 12% year over year in the first nine months of fiscal 2023 as the pandemic passed. Analysts anticipate 10% growth for the full year.
Chewy's number of active customers dipped from 20.4 million at the end of fiscal 2022 to 20.1 million in the third quarter of fiscal 2023. It's trying to offset that slowdown and growing its net sales per active customer by pivoting toward higher-margin products, expanding its Chewy Health Insurance plans for pets, and selling more ads across its online marketplace.
But at the same time, Chewy faces intense competition from brick-and-mortar pet retailers like PetSmart, which also sells its products online; and Amazon, which has started selling more private-label pet products over the past few years.
That's worrisome because Chewy still operates at low-single-digit adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margins and isn't consistently profitable on a generally accepted accounting principles (GAAP) basis yet. Analysts expect its adjusted EBITDA to rise 12% this year.
For fiscal 2024, analysts expect Chewy's revenue and adjusted EBITDA to rise 5% and 19%, respectively, as it offsets its slower growth with its pursuit of higher-margin products and services. Based on those expectations, Chewy's stock doesn't seem expensive at 16 times next year's adjusted EBITDA -- but its high-growth days might be over.
The better buy: Target
Target faces tough near-term challenges, but it's weathered plenty of downturns throughout its 56 years as a public company. It can leverage its scale to continue expanding and diluting its costs, its stock is cheap, and it can continue to pay attractive dividends for the foreseeable future.
Meanwhile, Chewy's slowdown suggests it's struggling to expand beyond its niche, and it could run out of run to grow its revenue per active customer to offset the persistent shrinkage of its customer base. Simply put, Target's stock might remain out of favor until its growth stabilizes again, but it's still a better buy than Chewy.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Chewy, and Target. The Motley Fool has a disclosure policy.
