2021 has been a great year for investors overall with the S&P 500 index up over 20% year to date. However, that hasn't been the case for shareholders of Peloton Interactive (PTON +1.89%). After rising a monstrous 500% from the start of the COVID-19 pandemic, the stock is down a whopping 70% year to date after reporting disappointing earnings and giving out unsatisfying guidance for its current fiscal year.
Peloton's business is definitely in worse shape than it was at the start of 2021. But with the stock trading at a steep discount, is now a good time to buy the dip on a pandemic favorite? Let's take a look.
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Disappointing first-quarter results
The majority of Peloton's latest price drop this year came after it reported fiscal first-quarter 2022 earnings, which covered the three months ended in September. Revenue came in at $805.2 million, up only 6% from the year-ago period. This was slightly worse than what analysts were expecting, and investors took it very poorly, sending the stock down almost 50% in the few weeks after the report.
On top of that bad revenue number, the company's gross profit margin fell to 32.6% from 43.4% a year ago. Management also sharply reduced its full-year guidance for the fiscal year ending in June of 2022. Fitness subscriber guidance was reduced from 3.63 million down to a range of 3.35 million to 3.45 million, revenue guidance was reduced from $5.4 billion down to between $4.4 billion and $4.8 billion, and gross margin guidance was reduced from 34% down to 32%.
This is not a good combination for a company expected to grow at a rapid rate over the next few years.
A few other things to worry about
Looking beyond the headline numbers, there were a few other things that should also concern investors. First, monthly connected-fitness churn (which measures the average number of paying fitness subscribers who left each month across the quarter) rose to 0.82% in Q1. That's up from 0.65% in the same period last year. While this may seem like a small difference, the durability of Peloton's subscription revenue is what will make this business profitable over the long term. Over time, investors should expect churn to decrease or stabilize. If not, the business will likely struggle to reach solid levels of profitability.
In addition, Peloton is having to spend a lot on sales and marketing right now. In Q1, that amount hit $284.3 million, up 148% from the same period last year. While there is typically a lag in marketing spend before it turns into sales, it is not a good sign that revenue only grew 6% year over year in Q1. Peloton's goal is to cover its sales and marketing costs with the gross profit from its connected-fitness business. However, with only $60 million in connected-fitness gross profit in Q1, the company is well below that goal.
Last is the company's recent common stock offering. Peloton raised over $1 billion by selling around 24 million shares at $46 a share. This is fine in a vacuum as Peloton will need the funds to help with its ambitious growth goals. However, on the conference call less than two weeks before the announced equity offering, Peloton's chief financial officer said the company didn't see the need to raise any additional capital. This was not a good look for management and is another reason why investors may have soured on the stock.
Reason to be optimistic
With all these negatives, one might think there's no reason to buy Peloton stock right now. But I will offer a few reasons for optimism. Connected-fitness subscribers, which will be Peloton's long-term profit driver, grew 87% year over year to 2.49 million in Q1. With an estimated 181 million gym memberships globally, management still thinks there is a long way to grow the number of subscribers to Peloton's service if it can maintain its lead in the connected-fitness market.
Also, member engagement has grown at a 42% compound annual rate in the past two years -- even if it decreased slightly from last year's Q1 at the height of the COVID-19 lockdowns. This indicates that Peloton's rising churn may just be a one-time blip since engagement should correlate to subscriber churn over the long run.
Lastly, Peloton is not resting on its laurels with its product portfolio. Research and development expense grew 167% year over year to $97.7 million in Q1, and CEO John Foley said that the company has multiple new products coming within the next 18 to 24 months. If the demand is there for more connected-fitness products, Peloton should be able to fulfill its role as the leader in the space.
So is Peloton a buy?
After reading the Q1 report, I don't have any hard views on Peloton. If you believe that the rise in churn, decreasing gross margin, and rising sales and marking spend as a percentage of revenue are short-term headwinds, then now could be a fantastic time to take a position in Peloton stock. But if you're unsure about the future of connected fitness and/or Peloton's growth trajectory coming out of the pandemic, it is probably best to stay away from the stock -- even with it down 70%.
