On July 12, Peloton Interactive (PTON -0.98%) announced its latest step in rightsizing its cost structure. The company said it is stopping in-house manufacturing and will outsource it entirely.
This comes as the interactive exercise-equipment company's revenue is falling amid the economic reopening. It's a major reversal from how Peloton thrived at the pandemic's onset when gyms were closed.
Let's look at what the most recent decision could mean for investors and if it's a compelling reason to buy the stock.
Why Peloton is outsourcing manufacturing
By outsourcing manufacturing, Peloton creates one significant change to its cost structure, moving more of its fixed costs to variable. Outsourcing allows Peloton to pay for the units it expects to sell plus some safety buffer. If it does not need any equipment, it will not need to incur the expense.
Consider the scenario it finds itself in right now. As of March 31, Peloton had $1.4 billion in inventory, an increase from $937 million in June 2021. This was not an intentional buildup to prepare for an upcoming surge in orders. Inventory exploded because sales abruptly turned lower as the economic reopening gained momentum.
PTON inventories (quarterly). Data by YCharts.
Therefore, Peloton might not want to produce more equipment until it sells through the existing inventory. This kind of pause in production can be more efficiently undertaken if you outsource the activity. With in-house manufacturing, the company would still need to pay employees, rent, and factory maintenance even if it chose to pause production.
But outsourcing has downsides. For one, Peloton is in the business of selling interactive exercise equipment. Therefore, it could gain an advantage over time as it climbs the learning curve on manufacturing this equipment. With each batch of units it produces, it could find refinements to lower costs, increase output, and boost features. By outsourcing, it is passing along this benefit to its supplier(s).
Essentially, this was a move of necessity. Outsourcing relieves the cost pressure on the company when liquidity is a significant concern. As of March 31, Peloton had $879 million of cash on hand. Meanwhile, it lost $1.6 billion in cash from operations in the past nine months.
The stock is cheaper than ever
PTON PS ratio. Data by YCharts.
This change alone is not positive enough to make Peloton stock a buy. However, it is down 95% off its high and trading at a price-to-sales ratio of 0.69. This extreme discount gives investors a meaningful potential reward for taking on the risk of buying Peloton stock in the hopes of a turnaround.
Outsourcing manufacturing could give the company's new CEO, Barry McCarthy, more time to pull that off.
