Shares of Peloton Interactive (PTON -0.55%) are trading well off their highs from a few years ago. Sales of Peloton Bikes cooled as more people returned to the gym as the pandemic eased, but the company's popularity and membership base of 6.7 million is causing value investors to take a second look at the once fast-growing connected-fitness brand. 

After falling from an all-time high of $171 down to $6.66 last year, the stock has rebounded around 25% over the last six months. 

Let's look at what Peloton is doing right, and whether buying the stock today is a smart move.

Improving margins and profitability

After seeing sales collapse through the first half of fiscal 2023, investors were upbeat following the company's last earnings report, for the December-ending quarter. Through the first half of the fiscal year, sales of connected fitness products were $585 million compared to nearly $1.3 billion in the same period a year ago. But while quarterly revenue was down year over year, it grew 29% over the previous quarter. 

Most importantly, Peloton made considerable progress to shore up the bottom line. The company cut marketing spending nearly by half, which was the biggest expense a year ago. It also made progress to clear out excess inventory, which significantly improved free cash flow (cash from operations minus capital expenditures).

PTON Free Cash Flow Chart

Data by YCharts.

After reporting a quarterly net loss of over $1 billion in the fiscal fourth quarter of 2022, Peloton has reported narrowing quarterly losses since, and management says it is on track to reach breakeven on the basis of free cash flow by the end of fiscal 2023. 

Opportunities to watch

One business opportunity helping Peloton improve profitability is subscriptions, not just through the connected exercise equipment, but also through the Peloton app, where members can access a range of workout classes for $13 per month.  

Last quarter, total gross profit (revenue minus cost of goods sold) was just $235 million. This is the money the company has left over to pay operating expenses (e.g., marketing). However, gross profit from subscriptions alone was $278 million, up 21% year over year and 2% over the previous quarter.

The high-margin subscription revenue was the company's biggest revenue source last quarter, which could have lasting implications on future profitability. "If this trend continues, which seems likely since we sell more hardware in [the second quarter] than any other quarter of the fiscal year, it represents a structural shift toward improving [gross profit margin] in the business," CEO Barry McCarthy said in the quarterly shareholder letter. 

A Peloton member engaging with the app outdoors.

Image source: Peloton Interactive.

Indeed, fitness as a service (FaaS) is an opportunity to watch. While it's too early to say whether Peloton can successfully build a profitably growing business with an all-access subscription, including hardware and workout classes, for a regular recurring fee, McCarthy said on the earnings call that its FaaS business is growing rapidly. 

Still, Peloton's total member base across all subscription offerings was flat at 6.7 million last quarter and down 1% year over year. This highlights the biggest problem for the investment case: growth.

On that note, other brands are struggling, too, including Bowflex owner Nautilus, which saw a significant drop in sales last year. Peloton executives used the phrase "figuring out" a few times on the fiscal second-quarter earnings call when discussing future growth. That suggests the turnaround is still a work in progress, and there is uncertainty about how revenue will perform in a post-pandemic world.

For this reason, I would keep the stock on a watch list and continue to monitor the company's performance in revenue growth, memberships, and profitability. It's also a good idea to watch how Peloton performs relative to low-cost gym operators like Planet Fitness, which has experienced solid revenue and earnings growth over the last few years. 

Until Peloton shows it can sustain top-line growth and deliver a healthy profit, I would avoid the stock.