Peloton (PTON 9.43%) was an investor favorite during the COVID-19 stock market bubble. Now, with the pandemic in the rearview mirror, an abrupt exit from founder/CEO John Foley, and the air coming out of the bubble stocks, Peloton shares have nosedived. The stock is down 60% over the past year and significantly more from its peak in early 2021 as the company started to hemorrhage money and lose demand for its at-home fitness products.
But this year, Peloton shares have started to stage a comeback, up a whopping 44% so far in January. Does that mean the worst is over for Peloton shareholders? Let's investigate
Recent developments
When John Foley left Peloton, a renowned executive from Netflix and Spotify named Barry McCarthy took over the helm as CEO. And Foley left him quite a mess to clean up. Peloton drastically miscalculated consumer demand for its exercise equipment in 2022, building up huge amounts of inventory and planning a new manufacturing hub called the Peloton Output Park in Ohio. Turns out that way fewer people wanted to buy $2,000 exercise bikes when they were able to leave their homes to exercise, leading to a huge decline in customer orders throughout late 2021 and early 2022.
In the first quarter of calendar year 2022, Peloton's hardware revenue declined 42% year over year. This led McCarthy to make major changes at Peloton, as the company was now burning almost $750 million a quarter in free cash flow and would have gone bankrupt sometime last year on its previous financial trajectory. These changes included major employee layoffs, reorganizing its supply chain to rely much more on third-party partners (which lowered its fixed costs), and raising debt to help shore up liquidity during this crisis.
Since then, the company has somewhat turned around this cash burn by "only" burning $246 million last quarter. Its connected fitness subscribers -- who pay high-margin subscription revenue each month -- continued to grow and almost hit 3 million at the end of September, while management also entered into distribution partnerships with Amazon and Dick's Sporting Goods and launched a rowing machine called the Peloton Row. The company is still in terrible shape, but McCarthy has started to make some improvements in a year or so as Peloton's new leader.
Why the worst is yet to come
Famous investor Warren Buffett has been quoted many times as saying that it doesn't matter how smart an executive is -- they cannot magically turn a terrible business into a good one. I think that is what is occurring at Peloton today.
The company is still burning around $1 billion in cash a year at its current run rate. Sure, McCarthy and the new executive team have a solid subscription business, but this subscriber base will have to grow significantly over the next few years in order to achieve positive cash flow.
Total gross profit at Peloton last quarter was just $217 million, which barely covers its $194 million in quarterly administrative costs, let alone major marketing and product development expenses. Connected fitness subscriptions are only projected to grow from 2.97 million to 3 million this quarter, which indicates to me that this rapid subscriber growth is not set to happen anytime in the near future, therefore keeping the company in a cash-burning state.
PTON Free Cash Flow (Quarterly) data by YCharts
At a market cap of $3.75 billion, some investors might think there is value in buying Peloton shares today. But there is no price low enough for a business that is structurally unprofitable. Stay away from Peloton stock unless the company starts generating consistent cash flow.
