Insights

Why Chewy, Ollie’s Bargain Outlet, and Petco All Slumped This Week

What happened

A broad swath of consumer-facing stocks traded lower this week, after a host of indicators suggested that the state of the economy had declined and things would get worse before they get better.

As a result, shares of online pet supplies retailer Chewy (NYSE: CHWY) tumbled as much as 11.7%, discount retailer Ollie’s Bargain Outlet (NASDAQ: OLLI) fell as much as 10.8%, and pet care specialist Petco Health & Wellness (NASDAQ: WOOF) was off as much as 7.7%. As the week closed, the trio were still trading lower, down 8.7%, 10.1%, and 5.5%, respectively, according to data provided by S&P Global Market Intelligence. The declines came even as the broader market rallied, with the S&P 500 gaining 4.3%, while the Nasdaq Composite climbed 4.7%.

There was very little company-specific news behind the sell-off, but several indicators of the health of the economy combined to drive these stocks lower.

So what

The week started out on a dour note for retailers and consumer discretionary stocks, as discount king Walmart issued a profit warning and updated its guidance. In a press release Monday, the discount store said it was lowering its outlook for the second quarter and the full year. 

CEO Doug McMillon suggested consumers were feeling the pinch, noting in a statement: “Food inflation is double digits and higher than at the end of [the first quarter]. This is affecting customers’ ability to spend on general merchandise categories and requiring more markdowns.”

The Federal Reserve added fuel to the fire on Wednesday, raising interest rates by 0.75%, the second such rate increase in as many months, and its highest rate since mid-2019. Federal Reserve chair Jerome Powell also suggested there could be another “unusually large” rate increase at the central bank’s next meeting in September. Consumers are reeling from 40-year-high inflation and rising interest rates are designed to push back inflation. That said, higher interest rates also make consumer borrowing all that more expensive.

Consumer sentiment was sapped once again this week when the U.S. Bureau of Economic Analysis delivered preliminary estimates for gross domestic product (GDP) for the second quarter, which slipped for the second consecutive quarter, meeting the historical definition for a recession.  

The only stock that had company-specific news contributing to its decline was Chewy. On Tuesday, Wedbush analyst Seth Basham downgraded Chewy to neutral (hold) from outperform (buy), but at the same time boosted its price target to $44, up from $35. The revised target was just 5% higher than Chewy’s closing price on Monday, so it was hardly a vote of confidence. 

Basham’s biggest gripe was that Chewy stock had gained 70% since late May and felt the shares were riskier after their recent run-up. He also cited anecdotal evidence that Chewy was experiencing a higher churn rate with recently acquired customers, which suggests a potential weakening in consumer spending and a tough road ahead.

Now what

It’s well known that consumer spending forms the bedrock of the economy and while shoppers have held up well thus far, there appear to be cracks in the façade.

Still, there are reasons to believe that each of these stocks could hold up well, even as the economy falters. Chewy and Petco both have the luxury of catering to our furry friends, and the pet care industry has held up remarkably well in previous downturns. While people may cut spending on many things, pets are one area that is historically immune.

When it comes to recessions, shoppers tend to look for discounts and bargains, which is Ollie’s bread and butter. Other discount retailers, including Walmart, are generally considered to recession-resistant, though not recession-proof.

Data by YCharts

Investors in these companies can also take solace in the fact that Ollie’s, Chewy, and Petco are already near historically low valuations, trading at two, two and one times sales, respectively, falling strictly within the definition of a good price-to-sales ratio.

Given that these stocks are (relatively) recession resistant and already near historically low valuations, investors should buckle in and hang on for the ride.

Danny Vena has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chewy, Inc. and Walmart Inc. The Motley Fool recommends Ollie’s Bargain Outlet Holdings. The Motley Fool has a disclosure policy.

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