Why It's Worth Holding On for Peloton's Bumpy Ride

It wasn't a great start to the new fiscal year for Peloton (PTON +2.34%). When the company reported its Q1 earnings on Nov. 4, investors reacted negatively and shares dropped over 35% by market close on Nov. 5.

At first glance, the results reported by the interactive fitness company seemed to warrant the sell off. An incredible run of stock performance in 2020 had inflated both the company's valuation and investors' expectations. However, there is reason to believe this is simply a bump in the road and that the market's reaction may have been overblown. 

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Distorted expectations

For the past year and a half, all of Peloton's earnings results have been viewed through the lens of the pandemic. It was largely good news in 2020 as the pandemic-induced lockdowns resulted in year-over-year revenue growth in the triple digits and total members growing from 2.0 million to 4.4 million. These eye-popping quarterly results had investors excited as well. Peloton ended 2020 with a share price of $151.72 and a price to earnings of 130, showing that there were expectations of the growth seen in 2020 continuing into 2021. 

Last week's results told a different story. Revenue only grew 6% year over year, and several other key metrics that Peloton uses to evaluate its own success saw decreases or decelerating growth. While year-over-year total connected fitness subscriptions and total connected fitness subscription workouts grew 87% and 55% respectively, the number of average net monthly workouts decreased 20% and net monthly connected fitness churn increased from 0.65% to 0.82%.

Source: Peloton company filings

None of these results should be particularly surprising to investors. In a quarter where the world continued to open up, more members churned and there were less monthly workouts. What's concerning is that management didn't seem to see this coming. That being said, the continued growth in subscribers bodes well for the long term success of the business.

Curbing future guidance 

It wasn't only investors who may have had outsized expectations for Peloton's performance. On the Q1 2022 earnings call, CEO John Foley explained the company's reduced guidance, saying "As we prepared our previous guidance, we had to make assumptions about consumer behavior coming out of COVID, the impact of our original bike price reduction and the cost structure within our connected fitness segment, all against the backdrop of a global supply chain crisis." Foley went on to say that reduced website visits and retail showroom traffic, normally a predictor of future results, contributed to the gloomier sales forecast that led to the guidance downgrade.

Using Peloton's updated guidance, here's how fiscal year 2022 would compare to the past two years. While not all these metrics are heading in the right direction, management expects to be adjusted EBITDA positive by the end of 2022.

Source: Peloton company filings

These 2020 estimated results represent a slowdown from the growth seen between 2020 and 2021, connected fitness subscriptions and total revenue are strong on a two-year basis. Using the midpoint of the 2022 guidance, connected fitness subscriptions would be up 209% and total revenue would see an increase of 155%.

Rightsizing expectations

It may be that the market's reaction to these results were more about managing the expectations coming out of the pandemic than the actual strength of Peloton's business. Viewing these same results over a two-year period -- which eliminates the impact of the pandemic -- tells a different story.

Connected fitness subscriptions grew from 562,000 in Q1 2020 to 2.5 million in Q1 2021, an increase of 345% over that two-year span. Over that same time frame, customer churn has improved slightly from 0.90% to 0.82%. Total workouts grew 528% to 120.5 million and average monthly workouts increased 42% to 16.6. Taken without the noise of the past year, these metrics show a healthy business growing steadily. Additionally, Peloton's Net Promotor Score (NPS), an indicator of customer satisfaction, is 74 , which is outstanding and significantly higher than the NPS of 50 it had two years ago. This shows that, not only is the business growing, but it's continuing to please its customers.

Is there hope on the horizon?

There are other reasons to be hopeful. While subscriptions are currently only 38% of total revenue, that's up from 21% one year ago. This is important because the subscription segment has a substantially higher gross margin of 67% compared to the connected fitness segment's 12%. In an instance where management did not have to revise guidance, CFO Jill Woodworth said in the last earnings call that Peloton is still on target to reach its goal of 70% subscription contribution margin by the end of this fiscal year. 

With the massive price cut that followed the latest earnings report, Peloton presents a better valuation for prospective investors. As of this writing, Peloton trades at only 4.1 times its trailing sales and is near its 52-week low share price at $51.25. This was not a great quarter for Peloton, both in terms of results and management's ability to accurately guide for its future results. Now may not be the time to start a position, but for current shareholders it may be worth holding, but keeping an eye on the next few quarters to see if these recent results are a bump in the road or a more worrisome trend that changes the long-term investment thesis.