The COVID-19 pandemic has significantly altered daily routines, spurring people to learn, work, and exercise from home. The resulting reliance on at-home fitness equipment has made Peloton Interactive (NASDAQ:PTON) one of the leaders of the at-home fitness industry, helping its stock price surge more than 270% year to date. Those gains suffered when news of multiple promising COVID-19 vaccines led investors to dump the stock. But Peloton's long-term competitive advantages have nothing to do with the pandemic, suggesting that savvy investors may be able to benefit from the market's overreaction. 

A man rides Peloton's Bike+ exercise bike.

Image source: Peloton.

Demand continues to increase quarter over quarter

Peloton's high-end product line has created a very strong brand presence in the industry. Its stationary bikes and treadmills are equipped with high-resolution connected screens that allow users to participate remotely in a real-time group workout from the comfort of their own homes.

The various models that Peloton offers are not cheap, ranging from $2,000 to $4,300. Customers who find that price tag daunting can pay by installment with zero interest, which has made this model a popular payment method for consumers.

At the end of September, Peloton reported its first-quarter earnings for fiscal 2021. Revenues came in at $758 million, up 232% year over year – though that growth rate has slowed from the previous two quarters' numbers. With COVID-19 cases rebounding, the strong demand for at-home fitness equipment is very likely to continue in coming quarters. Peloton expects it can earn $1 billion in revenue  in this quarter .

In its most recent quarter, Peloton's net profits came in at just over $69 million, or $0.20   per diluted share. The company has now posted profits for the last two quarters, and with demand continuing in 2021, there is no reason why it should not remain so in the near future. Although Peloton's strong performance in recent quarters was undoubtedly boosted by short-term tailwinds, those profits can probably persist, thanks to some enduring advantages that have nothing to do with COVID-19.

Subscription revenue creates sustainable profits

Peloton's subscription model is the backbone behind its long-term sustainable profitability. Users can join remote classes for   as little as $39 a month. The Peloton Digital App is also available for $12.99 a month, allowing users to connect to the Peloton online ecosystem and track your workouts and your overall progress toward fitness.  

Revenue from Peloton's Connected Fitness line reached an impressive $600 million in the most recent quarter, up 274% year over year. Astonishingly high Connected Fitness revenue   is good, but Peloton doesn't just sell bikes and treadmills. It wants to have "an ongoing service relationship will extend for many, many years," according to co-founder and CEO John Foley in the company's latest conference call. That subscription service makes Peloton different from traditional fitness equipment companies, generating an ongoing revenue stream instead of a series of one-off sales.

Subscription revenues alone reached $157 million in Peloton's most recent quarter, representing incredible 133% year-over-year growth, and illustrating just how much Peloton has become a hot pick for at-home fitness.  

By the end of the previous quarter, Connected Fitness subscription users totaled 1.33 million, representing 137% growth from the prior year. Even more impressively, the Peloton Digital App subscription base skyrocketed by 382% to 510,000, which brings the total market of subscribers to 3.6 million.     And the popularity of Peloton's products with the people who use them suggests that this expanded user base could provide a sturdy foundation for future recurring income growth.   

Peloton user stickiness is very high

In terms of customer usage, we can look at some important indicators that illustrate Peloton's success. Peloton's average net monthly connected fitness churn in the previous quarter was only 0.65%, shrinking 0.25 percentage points from the same time period last year. The retention rate for the preceding 12 months was 92%, which signals an impressive ability to retain users via Peloton's subscription model.

The total number of workouts by users increased by a whopping 306% year-on-year last quarter, and the average monthly number of exercise sessions per connected fitness subscription account reached 20.7 last quarter, up 76.9% from 11.7 in the year-ago period. The increase in total workouts and average workouts per month shows just how much Peloton's growth has accelerated.  

What makes Peloton so sticky? Content is king. Although Peloton already has thousands of on demand and live classes, it keeps investing in producing high-quality new ones. The launch of Barre classes was also a great success – users participated over 530,000 times in the last quarter . This abundant, high-quality content helps to entice customers to stay – as do Peloton's newly themed workouts featuring the music of superstar Beyonce.  

Should investors worry about a decline in Peloton's gross margin?

Peloton's current impressive subscription growth rate may further increase as the company continues to expand globally. Peloton's gross profit margin on its subscription revenue increased by 2.4 percentage points year over year to 58.5% in the last quarter.    

But Peloton's overall gross profit margin fell by 2.7% year over year to 43.4% in the most recent quarter. The main reason for the decline was obvious: Peloton proactively cut prices on its basic model line of stationary bikes to attract new members. The drop in its price was music to consumers' ears, but of course it ate into the company's bottom line.  

Generally speaking, we can expect that higher-priced products have higher gross profit margins, so it is not surprising that after the bike price of basic model was reduced, and the newly launched, higher-end Bike+ model experienced a supply shortage, Peloton's gross profit margin would get hurt. However, we can reasonably expect that when the supply of Bike+ stabilizes, the gross profit margin of connected fitness products should rebound.

A bright future ahead

Fitness at home has become a necessity, not just a trend. We can reasonably expect the demand  to remain strong even after the pandemic is over. First, let's recall that Peloton's revenue grew 110% year over year in fiscal 2019, even without the impact of COVID-19. Second, the demand for its new products, such as Bike+, looks robust. Finally, Peloton is growing in new markets, and it remains in its infancy with regards to global expansion.

Peloton is an innovator and a disruptor in the fitness industry. Fools interested in it might see this price drop as a good buying opportunity.

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.