Shares of Peloton Interactive (PTON -0.32%) are in the bargain bin after crashing nearly 90% since reaching an all-time high in early 2021. But Peloton might be gaining new customers at a higher clip than investors realize, which could spell upside off these lows.
One analyst from Morgan Stanley sees the potential for Peloton to surprise the market when it reports fiscal 2022 third-quarter subscriber numbers. If the analyst is right, investors could see a near-term recovery in the shares. It's worth noting the average near-term price target from Wall Street analysts is $46 at the time of this writing. That is more than double the stock's current price of about $20.
Let's review where Peloton currently stands, and why better-than-expected subscriber numbers could send the stock higher.
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Low growth expectations reflected in the stock price
The stock is currently down over 40% year to date after the company announced a restructuring effort in February to reduce its bloated cost structure amid slowing growth.
Peloton saw soaring sales during the pandemic in calendar 2020 and through the early part of 2021 as many consumers looked for at-home workout options. As demand for exercise equipment leveled off in recent quarters, management had to roll back its manufacturing expansion plans as it grappled with too much inventory. For full-year fiscal 2022, management has already reduced its revenue guidance twice, from $5.4 billion to a range of $3.7 billion to $3.8 billion. The latest outlook implies the top line will shrink slightly from fiscal 2021's $4.0 billion. The company also expects EBITDA losses to come in at $650 million on an adjusted basis.
But the market is a discounting mechanism. The stock price already reflects the expectation for weak operating results -- that's why the stock is down. The most important thing is that Peloton's valuation is dirt cheap right now. Over the last year, the stock's price-to-sales ratio has fallen from around 20 times trailing sales to just 1.7. Keep in mind the average stock that comprises the S&P 500 index trades at 2.9 times sales. This shows Peloton shares are likely undervalued.
Data by YCharts.
Because connected fitness subscriptions generate a much higher margin than sales of Peloton's exercise machines, investors are laser focused on how subscriptions perform. Better-than-expected connected fitness subscribers in the next earnings report could change the narrative around Peloton stock and fuel a rebound in the share price.
This is why the recent note from Morgan Stanley analyst Lauren Schenk could be good news. Morgan Stanley's Peloton website tracker showed the company adding a net 264,000 connected fitness subscribers in the March quarter. That is significantly higher than company guidance that calls for 160,000 net subscriber additions.
Since Peloton's contribution margin from subscriptions was 71% compared to just 6% for hardware in the last quarter, subscriber growth is a long-term catalyst for improving profitability.
Peloton is leading the connected fitness market
We don't want to fall into the trap of focusing on short-term price movements. The main point here is that when things turn bad for a company, the market often tends to oversell the stock. This can create opportunities that can lead to outsized returns if the company continues to outstrip investor expectations.
That said, investors should think about the following comment from CFO Jill Woodworth during Peloton's fiscal second-quarter earnings call: "Our own attitudinal research, as well as others published recently, has shown that openness to working out at home, and connected fitness, in particular, is now at levels much higher than they were pre-COVID."
Not only is the interest in at-home workout solutions still high, but Woodworth also noted that Peloton gained market share in the connected fitness market over the last year. That's noteworthy given the increased competition. As a leading brand in this market, it indicates Peloton is positioned to return to growth at some point.
Investors might want to wait and see progress in the turnaround effort underway before buying shares. Still, as the average analyst price target suggests, Peloton's low valuation looks awfully tempting. If Peloton does follow through with strong subscriber numbers next quarter, that could be a convincing buy signal.
