Throughout the worst of the pandemic, and even beforehand, Peloton Interactive (PTON -2.24%) was posting year-over-year revenue growth of at least 100%. What's more, the integrated fitness pioneer more than tripled its total membership count between calendar 2019 and 2021. As a business that practically created a new category in the industry, Peloton was in full-on growth mode.
But the tables have since turned. Management overestimated demand as the economy reopened, and as a result, the company finds itself burning through cash. New CEO Barry McCarthy now has a pressing strategic objective. "For the business in fiscal year '23, positive cash flow trumps growth," he said on the latest earnings call.
Investors who are familiar with the company's rapid historical growth must now get used to a Peloton that is fully focused on cost savings and improving the financial picture. And this is exactly what shareholders should demand right now.
Image source: Getty Images.
Management is strengthening the balance sheet
Notwithstanding market conditions in recent months, investors usually have a love affair with growth stocks. Owning companies that are able to sustainably increase revenue at a fast clip over time can translate to outstanding returns. Also, these businesses are often industry disruptors, helping to attract investor interest.
In Peloton's case, however, the financial situation needs to be fixed before anything else. After taking out a five-year, $750 million term loan, the company has $1.6 billion on its balance sheet, which probably couldn't come at a better time, given its weak demand and continued net losses.
Additionally, the leadership team must do a better job at managing inventory levels to free up cash. Throw in major cost cuts stemming from lower operating expenses, reduced marketing spend, and an optimized logistics network, the expectation is to generate positive free cash flow starting in fiscal 2023 on the back of "$800 million in annual run-rate savings."
Once management is comfortable with the company's financial footing, the company must decide how to properly invest for expansion. On the earnings call, McCarthy highlighted new geographies and new products as levers to pull in order to achieve higher levels of growth. However, the issue is that these initiatives take time to become profitable.
For example, international markets must reach a certain scale, leveraging expenses for things like warehousing, delivery, and marketing, to actually make money. And introducing new products like the Guide and upcoming Rower, obviously requires a lot of upfront capital in research and development before any revenue can be realized. Foregoing growth in exchange for financial strength is the right move today.
How should shareholders interpret this?
Peloton was founded in 2012, so it still has a short history. Throw in a once-in-a-lifetime event like the pandemic, and it's not a surprise the business is dealing with some major growing pains. Furthermore, innovative connected fitness is a new category the company is pioneering, so there is no clear playbook management can look to for guidance.
John Foley, the previous CEO and co-founder hoped to grow as quickly as possible. With McCarthy, investors are getting a leader with extensive experience as a CFO. Improving an enterprise's finances is his strong suit.
The positive is that there is legitimate demand for what Peloton offers, and members are fanatical about the workout experience. In the near term, ensuring survival, particularly in an uncertain economic environment, is absolutely vital. Producing free cash flow starting next fiscal year would prove the company's durability.
But over the long term, I expect the business to get back on track to posting substantial growth. Therefore, with the ongoing strategic changes that are happening at Peloton, shareholders should show some serious patience for this once skyrocketing stock.
