Coronavirus countermeasures have shut down gyms and entertainment venues, and people across the world have turned to online, virtual classes as a way to stay fit and cope with the added stress. As a result, the hugely popular home workout brand Peloton (PTON 1.11%) experienced a jump in interest, which has translated to a large rise in quarterly revenues. However, since its mid-March lows this year, Peloton's stock price has risen more than 260%. Do the underlying numbers justify such a leap?

Woman working out on a Peloton stationary bike while following an online class

Image source: Peloton

All-in for growth

Peloton has posted net losses since its IPO a couple years ago, despite its stellar growth. However, given management's heavy growth-oriented strategy, those losses may not be as dire as they look. 

Total revenue has increased from $218.6 million in June 2017 to $915 million in June 2019, reaching $1.4 billion over the trailing 12 months. Both subscription and equipment sales have nearly doubled every single year, although equipment sales have grown even faster since the end of Peloton's fiscal 2017. The company capitalized on this rapid growth to acquire one of its Taiwanese bicycle partners in mid-2019, giving Peloton increased control over its manufacturing and supply chain processes. 

Despite this, the company's net profit margin is -14% over the trailing 12 months, compared to a gross margin of nearly 45%. So what exactly is happening here?

Even as total revenue has increased, so have total operating expenses. For example, in the third quarter of fiscal 2020, total operating expenses as a proportion of revenue increased seven percentage points year over year, from 51% to 58% of total revenue. But excluding litigation and settlement fees from a lawsuit filed over music copyright infringement, operating expenses as a percentage of total revenue were flat compared to the year prior. In response to the coronavirus pandemic and a surge in demand, Peloton was able to pause all possible advertising, relying on increased word-of-mouth to further drive its sales, which balanced out the increased general and administrative costs. So the company clearly is aware of and able to control its operating costs as needed.

Overall, the company has posted shrinking net losses as a proportion of total revenue since going public. Its revenue growth has been outstanding, but management invests heavily in sales and marketing, as well as general administrative expenses, keeping net profits negative. That, coupled with consistently negative free cash flow, makes it clear that Peloton prioritizes further growth over earnings.

The path forward is obvious

Expectations are high for Peloton, since revenue is growing at a very strong pace and costs have increased in tandem. However, the company's growth-oriented focus is working to increase and solidify Peloton's market presence, and all things considered at the moment, this may be a wise strategy.

The coronavirus pandemic could offer a great opportunity to the company, as the trend toward working from home and avoiding gyms may allow Peloton to extend services to higher-earning, younger customers who are conscious of their health and eager to interact virtually with others. Peloton experiences very low churn rates of less than 1%, which indicates that both its equipment and class subscriptions carry wide customer appeal and satisfaction. The company currently offers an extended free trial as part of its market capture strategy, and this may help pull in potential customers during a time when economic uncertainty could otherwise prevent people from signing up. Assuming that potential customers will find continuing satisfaction in Peloton products, these free trials should eventually convert to paying accounts, further increasing the company's revenue.

Peloton is trading at a historically high trailing-12-month price-to-sales ratio, but this could be driven by rapidly expanding equipment sales and subscriptions, in addition to high expectations of future growth. The company's annual growth has historically peaked during its third fiscal quarter, with quarterly revenue falling during the fourth and first quarters as more users turn to exercising outdoors during the summer months. 

Future expectation is heavily factored into the current share price, yet Peloton's past growth rate and present business strategy do seem to support the idea that Peloton will continue expanding. Whether or not the company is valued fairly at this point is highly dependent on the quarterly results that it releases over the next half-year, as the pandemic effects wane over time. Will Peloton climb higher as a growth stock? It seems likely. Is the company trading at fair value? Only time will tell.