Is Peloton Interactive Stock a Buy?

Peloton Interactive's (PTON -0.98%) stock plunged 18% on Aug. 25 following its fourth-quarter report. The connected fitness equipment maker's revenue fell 28% year over year to $679 million, missing analysts' expectations by $4 million. Its net loss nearly quadrupled from $313 million to $1.24 billion, or $3.68 per share, which also broadly missed the consensus forecast by $2.97.

Peloton's post-earnings drop erased its 20% gain from Aug. 24 in response to its decision to start selling its products on Amazon (AMZN -1.65%). The stock also remains more than 60% below its IPO price.

Image source: Getty Images.

However, some contrarian investors might still see some value in Peloton's stock, which trades at a forward price-to-sales ratio of less than one. Let's review the main challenges to see whether its stock is worth buying.

Why did Peloton's growth fizzle out?

Peloton sells high-end exercise bikes, treadmills, and other fitness products that tether its users to its subscription-based streaming video workouts. Many investors were initially skeptical of Peloton's business model when it went public in September 2019, but its growth rates skyrocketed in 2020 as gyms closed down throughout the COVID-19 pandemic.

In fiscal 2020, which ended in June of the calendar year, Peloton's revenue doubled to $1.83 billion, its connected fitness subscribers more than doubled to 1.09 million, and its number of workouts more than tripled. In fiscal 2021, its revenue soared 120% to $4.02 billion, its connected fitness subscribers grew 114% to 2.33 million, and its number of workouts nearly tripled.

Unfortunately, that growth fizzled out in fiscal 2022 as the lockdown measures ended and other companies launched similar connected fitness products and services. A disastrous recall of its connected treadmills last May also tarnished its brand and exacerbated that pain.

Data source: Peloton. YOY = year over year.

Peloton ended the fourth quarter of 2022 with 2.97 connected fitness subscribers, but that marked an anemic gain of about 4,000 subscribers from the third quarter -- representing its weakest sequential growth (0.1%) as a public company.

For the first quarter, Peloton expects its growth in connected fitness subscribers to stay flat sequentially again but still grow 19% year over year. It also expects its total revenue to decline 21% year over year, so it isn't expecting its sales on Amazon to significantly boost its near-term growth.

What about Peloton's margins?

As Peloton's sales growth decelerated in a post-lockdown world, it slashed its prices to attract new users and widen its moat against cheaper competitors like Echelon, which also sells its products on Amazon. It also launched more streaming workouts that didn't require equipment to keep pace with more versatile services like Apple's Fitness+ and expanded beyond exercise bikes to compete against Lululemon's Mirror gym and other similar products.

However, those efforts and the supply chain headwinds caused its gross and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margins to crumble over the past year.

Data source: Peloton. EBITDA = earnings before interest, taxes, depreciation, and amortization.

Over the past year, Peloton laid off about a fifth of its workforce, outsourced its production to the Taiwanese manufacturer Rexon Industrial, and finally started selling its products on Amazon (in a drastic deviation from its first-party direct-to-consumer model) to stabilize its margins.

Those moves are gradually paying off. In the first quarter, Peloton expects its gross margin to rebound to 35% with a negative adjusted EBITDA margin of 14%-18%.

It's also gradually stabilizing its free cash flow (FCF), which came in at negative $412 million in the fourth quarter, compared to an average of negative $650 million over the previous two quarters. It optimistically expects its FCF to reach breakeven levels in the second half of fiscal 2023.

Peloton faces an uphill battle, but it won't go bankrupt anytime soon. It ended the fiscal year with $1.25 billion in cash and equivalents and still has access to an undrawn $500 million revolving credit facility.

It's not the right time to buy Peloton yet

Peloton is taking some steps in the right direction under its new CEO Barry McCarthy, who took back the helm in February. But it still hasn't proven its business model is sustainable in a post-pandemic world -- or that it can continue growing in the increasingly crowded connected fitness market.

Therefore, Peloton's stock deserves to trade at a discount for the foreseeable future. It won't attract any value-seeking investors until its revenue grows again and meaningfully narrows its net losses.