Everyone's talking about Peloton (PTON 3.65%) these days because it's a work-from-home story that's been on fire amid the COVID-19 pandemic. The fact the stock has appreciated by nearly 430% so far this year has certainly contributed to the chatter.
There's no doubt Peloton's business is booming. But will that continue?
The pandemic impact
Peloton's business has certainly been supercharged by COVID-19. Clearly, many more people are staying home, working from home, and avoiding public gyms more often. Peloton offers its subscribers a home-based interactive home-fitness platform with compelling fitness content and a social element of competing with or against friends. That offering has been extremely compelling during the pandemic.
The company's recent financial results would agree with that. Peloton's fiscal second quarter, reported in early February, called for achieving 920,000 to 930,000 Connected Fitness subscribers -- those who own a Peloton bike or treadmill and subscribe to the interactive content -- by the end of June. That would have been a stellar 81% growth rate for the year at the midpoint.
But soon after, COVID-19 caused demand to further accelerate, driving Connected Fitness subscribers up to almost 1.1 million by the end of June -- good enough for a 113% increase versus the prior year -- blowing away management's original guidance. That was the sixth-straight year Peloton has more than doubled Connected Fitness subscribers.
Management's guidance for its current fiscal year ending in June calls for more of the same. Connected Fitness subscribers are expected to reach "2.17 million or more" by June, which suggests at least 99% growth. More likely, the current fiscal year will be the seventh-straight year Connected Fitness subscribers more than double.
Image source: Peloton Interactive.
Anytime we see such an extraordinary track record, it's worth studying. COVID-19 has certainly accelerated demand, but Peloton's business has been on fire long before the pandemic came along. Why is that?
The primary reason is that it's simply an incredible user experience. That's clear from the company's Connected Fitness subscriber cancellation rate that's well below 1% per month, the incredible engagement as evidenced by 20-plus average workouts per month per Connected Fitness subscriber, and the 94 Net Promoter Score (NPS) among U.S. bike owners. (For those unfamiliar with NPS, a score above zero is considered good, above 50 is considered excellent, and above 70 is considered world-class.)
There are very few companies with world-class NPS scores. Peloton's scores clearly blow away even the world-class threshold.
What's to come
The pandemic has pulled forward lots of demand for Peloton. And that demand has outstripped the company's supply of bikes and treadmills. Today, Peloton's website indicates wait times are four to eight weeks for its original Bike and more than 10 weeks for the Bike+. Management has consistently told investors it expected to bring down those order-to-delivery times to more normalized levels of a week or two throughout this year, but the unprecedented demand has continued to make that impossible thus far.
The company's new greenfield manufacturing facility in Taiwan is expected to come online shortly after the new year. Management has said this facility should be able to produce 1.5 million bikes or treadmills per year. That should help fulfill demand in a more timely fashion, but management clearly doesn't think that's enough.
On the fiscal first-quarter conference call in November, management talked about adding manufacturing capacity and paying extra for air shipments of its Bike+ from Taiwan and expedited ocean shipping. Management also discussed investigating adding U.S. manufacturing capabilities.
This appears to have been a reference to the subsequent announcement of its acquisition of Precor, which is known for its commercial fitness equipment. But the key rationale for this acquisition appears to be the very large amount of manufacturing capacity Precor owns. The press release states:
The acquisition adds 625,000 square feet of U.S. manufacturing capacity with in-house tooling and fabrication, product development, and quality assurance capabilities in Whitsett, North Carolina and Woodinville, Washington. Peloton will be able to control the entire production process, from design to ship, and increase total production scale, while maintaining a high level of product quality. By making fitness equipment closer to U.S. consumers, Peloton will be able to deliver connected fitness products to Members sooner.
The deal is expected to close early in 2021, and the company expects to begin producing its hardware in the U.S. before the end of calendar 2021. That should enable meaningful sales growth.
Peloton is still a buy
Peloton's enormous demand growth is being held back by the company's supply constraints. But many customers are clearly willing to wait more than 10 weeks for one of Peloton's bikes or treadmills because the product and experience is so attractive. And as the company's Taiwan facility begins production shortly and the Precor production begins sometime next year, the company will fulfill more of that relentless demand. That should cause sales and profits to continue to grow at blistering rates.
The beauty of Peloton's business model is not the hardware sales, although those do have an attractive profit margin, but the ongoing subscriber relationships. The company can produce its interactive fitness content from its two production studios in New York and London, which is essentially a fixed cost, yet broadcast that content to a limitless number of potential subscribers. That means every incremental subscriber is extremely profitable, which should allow the company to be a cash-flow machine over the long term.
Peloton's high NPS and user enthusiasm suggest the company could easily have many tens of millions of Connected Fitness subscribers in the long run. That's true regardless of when COVID-19 hopefully comes to an end. Between that and the high profitability of every new subscriber, investors should still consider Peloton a buy.
