There's no shortage of boutique fitness options these days.

If you're looking for a pricey workout class, studios like SoulCycle and Barry's Bootcamp are popping up across the country. If at-home workouts are your thing, you might already own a Mirror or a Peloton (NASDAQ:PTON).

Peloton, which sells a $2,245 interactive exercise bike and a $4,295 interactive treadmill, has taken the exercise world -- and Wall Street -- by storm. Though its initial public offering in September initially seemed like a dud, the stock is now up modestly, following a strong fiscal 2020 first-quarter earnings report that showed revenue more than doubling, and strong feedback later from the company regarding its Black Friday sales.

With a valuation near $10 billion as of this writing, Peloton stock is clearly hot, and its sales growth has been rapid. But the company is deeply unprofitable and lost nearly $200 million last year. Other reasons to be skeptical of the stock include the highly fragmented nature of the fitness market and the company's high customer acquisition costs. However, the biggest reason to avoid the stock is that the market for Peloton's products, at least the premium ones that the brand is built on, is much smaller than the company believes it to be.

A Peloton cyclist in on her bike.

Image source: Peloton.

An expensive ride

Peloton's business model is built around selling high-end exercise equipment attached to subscriptions for interactive classes that cost $39 a month. The company also sells a digital subscription that people can access on other devices and use with non-Peloton equipment, for $12.99 a month, recently reduced from $19.49 a month.

Based on the 94% 12-month retention rate it achieved last quarter, the fitness specialist has so far been successful at keeping its customers happy. However, that may in part be a reflection of the fact that its subscriber base is composed largely of early adopters, who tend to be more committed and eager to try new products than the average customer.

Peloton has 563,000 connected fitness subscribers currently, and management says it believes it has a total addressable market of 45 million households in the U.S., or more than a third of Americans. It also sees a TAM of 67 million in all the countries where it currently operates, which include Canada, Germany, and the U.K.

Peloton doesn't explain where those estimates came from, and it defines the market as households open to subscription fitness that could be interested in purchasing a product from Peloton. But it does say that its potential customers fall within the 18 to 70 age range who have a total household income of at least $50,000. Of those, it says 36 million U.S households are interested in learning more about at least one Peloton product without seeing the price. It estimates its current serviceable addressable market -- those who are interested in its current products and at their current price points -- is 12 million.

As the company seems to acknowledge, the key impediment to it reaching a broader audience is the price. After all, this is a country where only 43% of Americans are confident they could come up with $2,000 if they needed it for an emergency. For the price of a Peloton Tread, you could buy a decent used car or take more than 100 SoulCycle classes. If you find the facilities at a budget gym suit your needs, you could join Planet Fitness for a basic rate of $10 a month and get nearly 20 years of membership for the purchase price of a Peloton bike.

The other problem the company faces is that Americans tend to overestimate their interest in fitness. According to the federal government, less than 5% of American adults get 30 minutes of physical activity each day, and more than 80% don't meet the guidelines for aerobic and muscle-strengthening activities. Notoriously, gym chains often count on a large share of their members joining with good intentions but then rarely showing up to work out, essentially giving them a cost-free revenue stream. That kind of person is unlikely to spend $2,000-plus on an exercise bike.

Not a mass-market item

By definition, a boutique product is not mainstream. It's expensive and only intended for a select group of customers. SoulCycle, for example, has just 98 studios around the country. Planet Fitness, by comparison, has more than 1,800 locations nationwide. 

The number of customers willing and able to consider a high-end product or service is naturally going to be much smaller than the number who could consider its mainstream equivalent. The phrase "cult-like" is often applied to the loyalty inspired by brands like Peloton and SoulCycle, but cults are small by nature, and such brands often lose their cachet when they go mainstream. 

Peloton can layer on more inexpensive options, as it did by discounting its digital app, or offer cheaper products, but doing that could undermine its business model as well as its boutique brand.

The track records of similar boutique fitness brands are not reassuring. SoulCycle initially filed for an IPO in 2015 but formally withdrew it in 2018. At that time, the company cited "market conditions" as being behind the decision, which is a polite way of saying that investors weren't interested. One of the issues the market appeared to be concerned about was the challenge SoulCycle faced from Peloton, a reflection of how faddish exercise trends can be. 

Similarly, YogaWorks, a small yoga studio chain with 46 locations nationwide, debuted on the market in 2017, but the stock almost immediately fell apart. Shares were delisted from the Nasdaq in July, and today, the company is worth just $3 million. 

It's clear that Peloton has an avid, devoted customer base, and its offerings clearly resonate with a certain segment of the fitness-minded population, but the ceiling for such expensive products is likely much lower than the company seems to believe. Peloton's growth rate won't stay hyperactive for much longer, and when it slows, investors will turn their gazes to the bottom line. If the company is still losing buckets of money then, its stock price could fall precipitously.