In 2021, investors in stay-at-home favorites like Zoom Video Communications (ZM 0.94%) have been disappointed, with most of these stocks negative for the year while the S&P 500 index has soared over 20% year to date. Peloton Interactive (PTON 3.53%), the company that sells at-home workout equipment and online workout subscriptions, has seen the same fate, with its stock down a whopping 40% year to date as of this writing. This is due to a rise in subscription churn and an equipment recall this spring.
If you're an investor in Peloton, there's no doubt you're hoping the rest of 2021 and future years are a lot better for this stock. Is Peloton ready to make a comeback? Let's take a look.
Image source: Getty Images.
Why is the stock down?
Outside of the shift in sentiment away from expensive stay-at-home stocks this year, it is likely that Peloton stock is down so much for a few reasons.
First, this spring it had a terrible accident with its new treadmill, the Tread+, when a child was pulled under the machine and died. After that accident and many minor accidents with the machine, the Consumer Product Safety Commission recommended that Peloton recall the treadmill in order to fix the issue.
At first, the company balked at the idea, with CEO John Foley refusing to recall the Tread+. But a few days later, he announced that Peloton would be recalling the machines and giving a full refund to customers. Aside from the financial impact on the company, the situation reflected poorly on Foley's management, which likely worried investors.
Second, in its fourth-quarter and fiscal year 2021 report, Peloton said its monthly churn rate elevated from 0.52% in the fourth quarter of 2020 to 0.73% in the fourth quarter of 2021. As I'll outline in the sections below, it is vital for Peloton's business model that customer churn stays low because of how important the connected fitness subscriptions are to this business.
Fourth-quarter results were good
In its fourth-quarter and full-year 2021 report, which covers the periods ending in June of this year, Peloton put up some solid results. Revenue was up 54% to $937 million in the quarter, which is even more impressive since it was lapping the middle of the lockdowns last year that gave the company a boost in demand. Connected fitness products revenue (equipment) grew 35% year over year to $655 million in the period, which included inorganic growth from its acquisition of Precor. Subscription revenue grew at a much faster pace than hardware, up 132% year over year in the period to $282 million.
Moving down the income statement, Peloton's gross margin for the fourth quarter was 27.1%, with hardware coming in at 11.6% and subscriptions coming in at 63.3%. Hardware's gross margin was depressed because of the costs associated with recalling the Tread+, but this discrepancy highlights why Peloton's subscription revenue is much more valuable to this business in the long term. With Peloton lowering the price of its original bike by $400 to $1,495 and management guiding for fiscal year 2022 gross margins of 34%, it is clear that this hardware/software gross margin difference will continue.
This means that Peloton is basically selling its equipment without plans to make a profit but recouping this through the high-margin workout subscription service that members can use along with it. The company explained this when outlining its guidance in the fourth-quarter shareholder letter, saying that it expects hardware gross profit to offset sales and marketing spend, but that subscriptions are what will make money in the long run.
The stock is more expensive than you might think
If, like management is saying, Peloton is looking to break even on equipment sales, investors really should just ignore hardware revenue and value Peloton on its high-margin subscription revenue. The segment is doing well, growing at over 100% year over year last quarter and hitting $872.2 million in revenue over the past 12 months.
However, with a market cap of $26.3 billion, Peloton has a price-to-sales ratio of 30 if you only include subscription revenue (remember, management is telling you its hardware segment is not meant to make money). This is very expensive, even for a segment growing north of 100% year over year. Now, if Peloton continues growing its subscription revenue at a high rate for many years, it is likely that this high current valuation will not matter. It is also exploring new revenue opportunities, like a Peloton Apparel line, that could build a lot of value for this business in the future.
But if you're an investor in Peloton, there's no reason the stock will make a comeback in the short term unless it can accelerate subscription revenue growth and/or reduce its monthly churn back to where it was during the heart of the pandemic. If that doesn't happen, you have to be comfortable with holding this expensive stock, since it likely will experience more volatility (up and down) over the next decade, just as it has in 2021.
