Peloton Interactive's (NASDAQ:PTON) fiscal fourth quarter couldn't have been better. Connected fitness subscriptions hit triple-digit growth rates as more people shifted to at-home fitness options. The quarter was so strong that management didn't have to spend much on marketing to drive sales, which lifted profits.
The pullback in marketing spending allowed Peloton to report its first net profit, but investors shouldn't expect earnings to continue growing. Peloton is launching new products, lowering prices on older products, and continuing to expand its manufacturing capabilities, which will require investment and pressure margins going forward.
Peloton has a profitable business model
Peloton reported an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin of 23.7%. That is above even optimistic analyst forecasts for the long term. Goldman Sachs had previously estimated that Peloton can achieve an adjusted EBITDA margin of 20% over time, given the company's lucrative subscription service.
Peloton's business model is based on heavy marketing spend in the early stages of growth to drive brand awareness. As awareness rises over time, management plans to gradually roll back that expense in proportion to revenue, which has typically hovered around 30% to 35% of the top line, to bring profits up.
COVID-19 accelerated that plan and gave investors a glimpse of where Peloton's profitability is likely headed. In the last quarter, marketing expense was just 14% of revenue, or less than half the level of the previous quarter. The pullback in marketing expense led to net income of $89.1 million, or $0.27 per share, in the fiscal fourth quarter. That is a healthy net profit margin of 14.7% of revenue.
Revenue exploded 172% year over year despite the light marketing. Peloton credited high revenue growth partly to undelivered Bikes from the previous quarter, in addition to strong organic demand during the pandemic.
Demand is incredibly strong right now as management expects revenue growth to accelerate again to 218% year over year at the midpoint of guidance in the fiscal first quarter of 2021.
However, management is guiding for adjusted EBITDA margin to fall back to single digits for fiscal 2021 (which ends next June) with a midpoint estimate of 6.6%. The guidance reflects light marketing spending in the first half of the year and then a return to more normalized spending levels in the second half of fiscal 2021.
Higher marketing and lower prices will pressure margins
Peloton will ramp up marketing again as the year progresses, especially for the holiday quarter. It still has potentially millions of customers to reach. The connected fitness subscriber base grew 113% year over year last quarter and crossed the one million mark, bringing the total global member base to 3.1 million.
Management has previously stated that the addressable market is 14 million, but that number might be underestimating Peloton's long-term potential.
Peloton just introduced a new Bike+ model and lowered the price on the original model by $350. The lower price on Bike+ and expected sales-mix shift to Tread+ will pressure gross margin in the near term. But management is optimistic about the potential to expand the market opportunity for its products with lower prices, as CFO Jill Woodworth explained on the conference call: "We do believe, of course, lowering the price of our product will have an impact on our serviceable, addressable market."
Where Peloton is investing
Peloton has plenty of initiatives on its plate. Management plans to continue investing aggressively in new products, manufacturing and distribution, new software features, and adding more workout programs.
Given the global market opportunity, investors shouldn't expect Peloton to suddenly prioritize reporting a profit over revenue growth. But the recent results validate how profitable Peloton can be over the long term as the subscriber base continues to grow and brand awareness increases.