Fitness company Peloton Interactive (PTON +1.30%) has been a roller-coaster ride for investors since the pandemic, rising as high as $171 per share before sliding to under $50 after its most recent quarter.
The volatility might be unsettling to investors, but sometimes fighting the fear and the stomach knots can be rewarding over the long term. Peloton's business has stumbled, but at near $50, the digital fitness business alone could justify owning the stock without factoring in the other good things happening at the company.
Why are investors fleeing Peloton?
Peloton benefited from the COVID-19 pandemic, where lockdowns prevented people from going to the gym, leading them to use Peloton to get their workouts in. Peloton's fiscal calendar turns over at the end of June (six months ahead of real time), so we can see below how sales and member engagement peaked at the height of the pandemic, the winter of 2020 and early 2021. These are the 2021 second and third quarters below.
| Quarter | Revenue (million) |
Monthly Workouts per Connected Fitness Subscription |
|---|---|---|
| Q2 2020 | $466.3 | 12.6 |
| Q3 2020 | $524.6 | 17.7 |
| Q4 2020 | $607.1 | 24.7 |
| Q1 2021 | $757.9 | 20.7 |
| Q2 2021 | $1,064.8 | 21.1 |
| Q3 2021 | $1,262.3 | 26.0 |
| Q4 2021 | $936.9 | 19.9 |
| Q1 2022 | $805.2 | 16.6 |
Data source: Peloton.
Over the past two quarters, we see both sales and member engagement steadily reverting back to historical averages. Investors are afraid that Peloton is simply a "COVID stock" that will fade as more people become vaccinated and begin returning to the gym to work out.
Image source: Getty Images.
Additionally, management ramped up spending to handle the surge in business it saw in 2021 Q2 and Q3. In 2022 Q1, operating expenses grew 140% year over year compared with just 6% revenue growth. Sales and marketing expenses also increased sharply, increasing 148% year over year. Management's revenue guidance for full 2022 ($4.4 billion to $4.8 billion) is a lot lower than what it guided for just the previous quarter ($5.4 billion).
Ramping up spending when revenue growth is sharply decelerating is unwise, and management appears to have misjudged the trajectory of its own business; this is a fair point of criticism.
Why Peloton is more than a COVID stock
However, there is evidence that Peloton is far more than a pandemic-dependent business and that it could still grow a lot over the coming years. First, Peloton was rapidly growing long before the arrival of COVID-19.
The company is currently on a seven-year streak of posting 100% year-over-year revenue growth, beginning in 2015. While the streak is likely to end in 2022 due to high comparables in 2021, it seems logical that the pandemic pulled some near-term growth forward.
There are a lot of opportunities for Peloton to grow over the long term. The company's digital fitness subscription business continues to grow and now has nearly 2.5 million members. The connected fitness business contributed roughly 37% of the company's total revenue in 2022 Q1.
Additionally, Peloton has primarily built its business on its legacy bike product. But the Peloton Tread is in its early years, and the company recently announced a strength training product that tracks exercise motion during training. Peloton's popularity has often been described as "cult-like," and it's a brand with high customer satisfaction, so these newer products have a solid chance of becoming meaningful contributors to the company's revenue mix over time.
Illustrating Peloton's attractive valuation
Hardware is traditionally a low-margin business, and while Peloton's equipment sales drive revenue growth, I get more excited about the recurring, higher-margin revenue that connected fitness subscribers bring. In 2022 Q1, the subscription business generated 66% gross margins.
Over the past 12 months, Peloton's subscription revenue has totaled $1.02 billion. With the company's market cap of $13.3 billion, investors are paying a price-to-sales ratio of 13 for its subscriber business and getting the equipment side of Peloton for free!
Meanwhile, some technology stocks are trading at P/S ratios of 50, 75, and even 100, in some cases. And while equipment sales have slowed down for Peloton, the number of connected fitness subscribers continues to grow each quarter and grew nearly 87% year over year in 2022 Q1.
Management has outlined a long-term goal of 100 million connected fitness subscribers, meaning that subscribers will eventually drive the business instead of equipment sales. As long as the subscription business continues to grow, the stock's volatility could be an excellent opportunity for long-term investors.
