On Thursday morning, Peloton Interactive (PTON 1.46%) reported the results from its fiscal 2024 second quarter, and the numbers weren't great. For the period, which ended Dec. 31, revenue declined 6% year over year and the business posted a net loss of $195 million, which was worse than the three months prior. In response to the report, traders sent Peloton's stock down by more than 20%. From its early 2021 peak, it is currently down more than 97%.
Nonetheless, risk-tolerant investors might be ready to take a closer look at this beaten-down consumer discretionary stock in the hopes that if its business gets back on track, the stock could enjoy a massive rebound over the long haul. But Peloton is one business I wouldn't touch with a 10-foot pole.
Turnarounds are difficult
There are few better examples to study than Peloton to gain perspective on how an enterprise can ascend rapidly and then plummet even faster. Of course, the company benefited from tremendous demand during the most intense periods of the pandemic. Its user base and sales skyrocketed. And investors were rewarded.
What's shocking is just how much the demand for Peloton's products and services dried up once social distancing efforts relaxed and consumer behavior stabilized. Its latest quarterly revenue figure was a 34% decrease from the same period three years ago. Finding growth still appears to be a major challenge for the company.
The fact that Peloton is in the midst of a major turnaround effort should be a bright red flag for those considering the stock. I don't think anyone has a clue as to what this business will look like three years from now. Its ongoing losses make matters worse, as there is no telling when the cash burn will end.
CEO Barry McCarthy is doing his best to create a more efficient organization. His focus is on registering more recurring revenue and getting Peloton to profitability sooner rather than later. He's two years into his tenure now, and there is still a lot of work to be done.
NASDAQ: PTON
Key Data Points
Does Peloton have an economic moat?
It makes sense to stay away from investing in a business that is experiencing a long period of financial troubles, as Peloton is. It's uncertain whether it can turn itself around, which adds more risk to the equation.
But what makes it incredibly clear to me that I really don't want to touch Peloton with a 10-foot pole is that I don't believe the business possesses an economic moat. This concept, popularized by investing genius Warren Buffett, refers to competitive advantages that position a business to outperform over the long term.
One might counter my argument by saying that Peloton does have a moat -- its strong brand in the fitness space. This is certainly true. The company's monster success during the depths of the pandemic made it a household name. And some of its fitness class instructors have achieved celebrity status.
I'm not arguing with this. But that supposedly strong brand hasn't boosted Peloton's financials back to health. One way to gauge a brand's strength and success is by looking at the company's gross profit. Peloton's connected-fitness segment, which includes its hardware products, registered a measly gross margin of 4.3% in the latest quarter.
Consumers haven't shown a willingness to pay up for advanced exercise equipment. Peloton's revenues barely cover the costs of manufacturing the gear, which suggests that its brand isn't as powerful as you might have thought.
Peloton's subscriptions command a stellar gross margin of 67.3%. But churn with the digital app in fiscal Q2 ticked higher quarter over quarter to a disappointing 7.2%. Moreover, there are many other competing digital fitness services out there. For customers, switching costs are nonexistent. And for would-be rivals, there are no meaningful barriers to entry.
This shows how difficult it is to build a sustainable moat in the fitness industry. As a long-term investor, it's smart to focus on companies with economic moats. Peloton doesn't.
So despite the stock trading at a ridiculously cheap price-to-sales multiple of just 0.6, I'm not buying shares of Peloton right now.
