• Chewy and Petco are increasingly reliant on pet health care for sales.
• Both companies have seen hard goods like toys and leashes trending down but have been building out their pet health care models.
• "Non-discretionary categories, including consumables and health care, remain the pillars of strength," said Chewy CEO Sumit Singh.

If there's one thing that's clear from Chewy and Petco's latest earnings reports, it's that pet health care will be key to whether the companies can grow and make higher profits over the longer term. 

The retailers, which both released their quarterly earnings on Wednesday, began investing heavily into pet health when the pandemic-fueled pet boom saw 23 million American households welcome a new animal into their homes. 

The boom turned the overall pet market into a $123.6 billion dollar powerhouse in 2021, and it's expected to grow.

Pet health care – and the high margins that come with it – is a crucial component to that overall market. 

The companies may still have to win over investors with the approach, though, as shares of both companies fell Thursday.

Chewy, the ecommerce giant known for its convenient auto-ship services and generous customer service policies, has focused on building out its pharmacy, insurance and telehealth verticals while partnering with veterinarians to get a cut of their consumables revenues. 

The company, founded by Ryan Cohen in 2011, now operates the largest pet pharmacy in the U.S., CEO Sumit Singh told investors on an earnings call. 

"Non-discretionary categories, including consumables and health care, remain the pillars of strength," Singh, a former Amazon executive, said on the call. 

Petco, on the other hand, has also invested into insurance and pharmacy but has focused on leveraging its brick-and-mortar footprint to set up veterinary hospitals. It changed its name to Petco Health and Wellness Company in 2020.

The longtime pet retailer now has a total of 247 hospitals across the country, up from 10 at the beginning of 2018, bringing a veterinary presence to 90% of Petco's stores, chairman and CEO Ron Coughlin said during an earnings call. 

"Petco's hospitals and clinics saw nearly 1.9 million pets in 2022, positioning us as one of the leading providers of veterinary services in the United States," Coughlin told investors, adding Petco is among the top 10 in the nation from a hospital unit standpoint. 

"Vet customers are also demonstrating a 2.3 times higher lifetime value than non-vet customers," he said.

Against the backdrop of a tough veterinary job market and a dearth of pet doctors, Petco hired 1,100 veterinarians in 2022, a 40% year-over-year increase.

Chewy has not shared how many veterinarians or vet techs it employs for its veterinary telehealth service, Connect With a Vet.

Long-term growth

The fruits of these labors haven't quite materialized just yet for both of the companies. The nascent initiatives are costly to build. But in the long term, they could provide a durable runway for growth and profitability. 

Pet adoptions surged during the pandemic, triggering a surge in demand for pet goods. With uncertainty in the macroeconomic environment and an increasingly cautious consumer, sales from high margin hard goods such as toys and leashes have been trending down at both companies.

At Petco, where discretionary supplies and companion animals account for about 38% of sales, the category suffered a 9% decline for the full year, the company said. 

At Chewy, which is not nearly as reliant on hard goods, the company celebrated its first annual profit in its history Wednesday. But executives also repeatedly noted softness in the discretionary and hard goods categories during the company's earnings call. Singh said he doesn't expect hard goods sales to accelerate in 2023.

Plus, there's now more competition in the hardgoods market, making it harder for Chewy and Petco to hang on to their market share, said Jessica Ramirez, a senior analyst at Jane Hali and Associates. 

"Off-price retailers have a really good category and those categories continue to grow," she told CNBC. 

However, when it comes to pet care, there are far more avenues for growth and longevity. 

"A puppy that was, you know, adopted or bought, during 2020 is now three years old. As they get older, they're only going to require more health care," said Anna Andreeva, a senior equity research analyst and managing director at Needham and Company. "And I think both companies are being smart in developing those verticals." 

Pet insurance has very little penetration in the U.S. compared to other markets, such as the UK, which can "definitely" be changed moving forward and will be another driver in the space, Andreeva said.

In addition, the footprint of independent veterinary providers is dwindling, which is creating an "interesting" market share opportunity, said Andreeva.

"There's definitely been, you know, share donation out of that channel," she said.

Obstacles and opportunities

The two companies share many similarities in the items that they sell and the customers they cater to but have taken different approaches to pet health. 

Chewy, which has no brick-and-mortar stores, has focused on building out its virtual telehealth capabilities but has run into obstacles because of state and federal regulations that, in some locations, forbid veterinarians from treating an animal if they haven't met it in person. 

"That is a bit of a complication and when you look to Petco, they are at a better advantage because they have stores," said Ramirez.

CNBC previously reported that Chewy, along with other pet companies, have sponsored a lobbying organization that's working to change those regulations and some veterinarians are concerned that veterinary telehealth could be unsafe and problematic for pets. 

Petco hasn't faced the same issues because they haven't yet branched into telehealth, and all of their veterinarians practice in physical locations. However, it will take some time before the hospitals are profitable.

"The margins on our services business are growing. It's a three year payback on those vet hospitals and we're ahead of our model on that," Coughlin, Petco's CEO, told CNBC in an interview.

Either way, as the consumer continues to focus on wellness and seek more ease to meet all of its needs, branching into pet health is a positive avenue for growth for both of the companies, said Ramirez, the Jane Hali analyst. 

"As wellness continues to be a key category for us the consumer, it's also being reflected into pet," said Ramirez. "It only makes sense that sort of lifestyle is extended to our furry animals at home because again, it makes everything much more streamlined, much easier, so I think that's something that makes sense on both sides."