Peloton Interactive (PTON 2.69%) is struggling to keep up with demand with so many orders coming from people wanting a convenient at-home workout during the pandemic. The stock has almost tripled since its initial public offering in Sept. 2019, but even at the current level of about $83 per share, one Goldman Sachs analyst -- Heath Terry -- believes the stock can reach $96. 

As long-term investors, we're not so interested in where the stock is headed short term. Instead, our focus should be on the next five years and beyond. With that in mind, Terry's reasons for the bullish call still lay out a strong case for why Peloton could be a good investment, even after its impressive rally year-to-date.

A woman using a Peloton bike in her bedroom.

Image source: Peloton Interactive.

High order volume is lifting profits

Peloton's latest guidance calls for connected fitness subscribers to double year over year to between 1.04 million and 1.05 million to end fiscal 2020. But Terry believes the company will beat its own guidance when it reports fiscal fourth quarter earnings on Sept. 10, reaching 1.09 million subscribers, based on comments from management about its increased production capacity during last quarter's earnings call

Management explained that the company has doubled production output, yet it is still way behind on fulfilling orders. CFO Jill Woodworth noted on the latest call, "While we are working to accelerate the supply of bikes and incurring higher costs in order to expedite shipments, we do not expect to materially improve order-to-delivery windows in Q4." 

One concern about Peloton's growth has been its path to profitability, but the escalated demand has pushed Peloton into the black sooner than expected. Management previously called for a loss based on adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) for fiscal 2020, but Peloton was able to throttle back marketing, given the organic demand from the pandemic and strong word-of-mouth. This is allowing more revenue to flow to the bottom line and puts Peloton on track to finish fiscal 2020 with an adjusted EBITDA margin of 2% at the midpoint of guidance.

How Peloton can sustain a profit

Peloton's business model is built around leveraging its fixed costs in studios and instructors and growing word-of-mouth referrals to lower marketing and other operating expenses as a percentage of revenue over time. This certainly played out last quarter as Peloton's sales and marketing expense dropped to 29.5% of revenue, down from 31.9% in the year-ago quarter. 

"With strong revenue flow-through and leverage against our fixed costs, we achieved our first adjusted EBITDA positive quarter as a public company in Q3 with an adjusted EBITDA margin of 4.5%," CEO John Foley said last May. 

Profitability should improve much more over time. Peloton's fiscal fourth-quarter adjusted EBITDA margin is expected to reach 11.8% at the midpoint of guidance, and that's despite higher costs related to shipping and COVID-19, in addition to the extension of the free 90-day trial to the Peloton app. 

The next hurdle

Lastly, the analyst believes that network effects are starting to kick in. These can be a powerful competitive advantage for a business with the basic premise that a service gets more valuable the more people who use it.

At the start of the fiscal third quarter, Peloton launched tags, a new social feature that allows members to connect with others based on shared interests such as a favorite sports team, employer, or geography. It's one example of how Peloton is trying to make its platform as sticky and engaging as possible.

Peloton will face a challenge near term trying to hang onto members as gyms reopen around the country. But before the pandemic, the company was already on pace to grow subscribers by 81% year over year in fiscal 2020, based on previous guidance. Peloton has been seeing rapid adoption that will likely continue beyond COVID-19.

But the challenge of keeping new members spinning those wheels is also why Peloton is building its platform around community and social features. "I think we're going to be able to convert and continue to attract a lot of our newest members, who we think might be hesitant to go back to the gym anytime soon," Woodworth said on the last earnings call.

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Remember that regardless of what the stock does the rest of the year, if Peloton can continue winning over new customers and keep its rate of subscriber churn low, the stock price will take care of itself over the long term.