Peloton Interactive (NASDAQ:PTON) is a rapidly growing connected fitness equipment and media business that's leading the reinvention of the home fitness industry. Here's why the stock is a buy.

Scale player but just getting started

Peloton has grown its connected fitness subscriber numbers at a blistering pace since its founding in 2012. At the end of its fiscal year ending June 2017, it had 107,708 subscribers -- a figure it more than doubled to 245,667 in the fiscal year ending June 2018 and more than doubled yet again to 511,202 in the fiscal year ending June 2019.

The annual doubling of connected fitness subscribers isn't over. On May 11, the company announced it had just passed 1 million subscribers. That's already 96% year-over-year growth, and there were still seven weeks to go in the current fiscal year at the time. The company was easily on pace to beat the 1,040,000 to 1,050,000 subscriber guidance for the end of June that it provided when it reported its last quarter.

A man rides a Peloton bike at home while a woman walks by him.

Image source: Peloton Interactive.

More importantly, the growth opportunity ahead is truly massive. There are 183 million gym memberships globally, including 90 million in the four markets Peloton is currently operating in -- the U.S., U.K., Canada, and Germany. While it's difficult to say how many of those gym members would consider buying a Peloton, it is fair to say that 1 million subscribers is a small percentage of the total opportunity. 

The rub with Peloton is its bike and treadmill are fairly expensive at $2,245 and $4,295, respectively. That said, the majority of customers take advantage of the 0% financing offer that's available from its financing partner, Affirm. With that offer, the bike and treadmill cost a more affordable $58 or $111 per month, respectively, for 39 months.

Peloton's objective is to "democratize" its offering by having a "better/best" product portfolio. That will include both the current high-end versions of its products as well as mass-market versions. That has the potential to make Peloton more accessible to more people, which could easily cause the subscriber base to balloon to 10, 20, 30 million or more over the next decade or so.

Big margin potential

Around Peloton's IPO, the company's management told investors to expect adjusted EBITDA profitability by fiscal 2023. But the effects of COVID-19 have quickly pulled profitability forward, primarily due to the company's elimination of advertising in most markets. Since so many people are actively seeking out Peloton's home fitness solution, and the company has more demand than it can supply at the moment, it doesn't make sense for it to spend money on advertising.

As a result, management expects the company's sales and marketing expense to be cut in half in the Peloton's fiscal fourth quarter ending June 30. Further, the company may never have to advertise as heavily as it did pre-COVID because of the powerful effects of word-of-mouth marketing as the company grows its connected fitness subscriber base.

Longer term, Peloton should have very attractive profit margins due to the company's wonderful subscription business. The company produces a relatively fixed amount of fitness content regardless of how big the subscriber base gets. That means it should have very high subscription gross profit margins, which will drive up overall profitability as the company scales.

Further, management expects substantial reductions in both sales and marketing and general and administrative expenses as a percent of revenue over time. The combination of much higher gross profit margins and leveraging these operating expenses should result in massive increases in company profits over time.

Ideally positioned for COVID-19

Peloton has been almost ideally positioned for COVID-19. Gyms and fitness studios have had to close, and many of us are spending much more time at home than ever before. Peloton's at-home connected fitness solution is ideal for those seeking to get great workouts from the comfort and safety of their own homes.

As a result of COVID-19, demand for Peloton bikes has gone through the roof. Order-to-delivery times have jumped from the usual one week or so to as long as 10 to 12 weeks. According to management, the company has doubled its bike production by June from early March levels. Considering that production has doubled yet order-to-delivery times still remain several weeks longer than usual suggests underlying demand is up well over 100% year over year. 

Between that and the far lower sales and marketing expenses required, Peloton is on the road to a very profitable future. That's why investors should consider Peloton a buy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.