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Peloton: buy the dip or losing stock?

Vineel Bhat   |   5/9/21

In the past few months, Peloton stock has plummeted over 50% from highs of $171 to now as of 5/9/21, only $83.81. This happened following a broad stay-at-home sell off in March, and then a string of bad events unfolding in April and May.

On Saturday, April 17th, the US Consumer Product Safety Commission (CSPC) issued a warning regarding Peloton’s Tread+ product, saying it poses “serious risks to children for abrasions, fractures, and death.” In addition, the commission advised consumers to stop using the Tread+ if small children or pets are around. Peloton responded with a press release marking the CSPC’s claims as misleading, and that there is no reason to stop using the Tread+.

Peloton shares tanked more than 6% for two consecutive days, falling below $100 per share for the first time in months.

The company received criticism from many for being unwilling to issue a recall. But on May 5th, the company turned 180 degrees, issuing a full recall of both the Tread and Tread+ products. Consumers can obtain a full refund, or request help to move their product to a safe place. Peloton CFO Jill Woodworth expects the recall to cost about $165 million. But investors are more concerned about the reputation damage Peloton could experience due to the initial refute of CSPC claims.

Peloton stock plunged another 15% to the low 80s, to where it hadn’t been since September.

Was this dip irrational? And is it a good time to jump in and buy Peloton stock? In this article we’ll do an in-depth dive into Peloton’s business: products, market, competitive advantage, opportunities, and risks, as well as financials and valuation, to find out if their stock is attractive at the current price (as of 5/9/21 – $83.81 price, $24.682B market cap).

Business Overview

Products

Peloton’s products & services include:

  • Connected fitness products (hardware)
  • Live online fitness classes (subscription)
  • Apparel and accessories

Connected fitness products include bikes and treadmills.

Peloton sells bikes in two models:

  • Bike   |   Starting at $1,895
  • Bike+   |   Starting at $2,495
Peloton Bike

The treadmills also come in two models:

  • Tread   |   Starting at $2,495
  • Tread+   |   Starting at $4,295
Peloton Tread+

However, the vast majority of Peloton’s connected fitness revenue comes from Bike sales.

Peloton’s subscription services grant access to a set of live and on-demand online fitness classes, and come in two variants:

  • Peloton All-Access Membership   |   $39/mo, bike & tread users only
  • Peloton Digital Membership   |   $12.99/mo, no equipment required
Peloton App Logo

Some of Peloton’s fitness class features include:

  • Leaderboard: Compete against other athletes in live classes, and try to beat your personal best metrics
  • High Fives: Send virtual high fives to other class participants
  • Friends: Follow & connect with friends, schedule classes together, and video call with friends
  • Tags: Showcase interests with #s to better connect with others

Lastly, Peloton sells a variety of accessories and apparel such as shoes and dumbbells.

Despite selling hardware, Peloton has a huge subscription component that will drive recurring revenue. A subscription service is available whether you have a hardware product or not. And those who do purchase a hardware product are stuck to the service – the giant screen is pretty much useless otherwise.

Market

Both Peloton’s connected fitness products and all-access membership are pretty pricy, and appeal mostly to those in the upper-middle class and higher.

Despite 40% of the US population earning under $50k/year, this group only made up 8% of Peloton’s consumer base in FY20. However, the company is increasingly appealing to lower earners, likely as costs and prices are reducing through vertical integration and increased scale. The under 50k subset increased from 5% in FY14 to 8% in FY20, while the over 200k subset decreased significantly from 41% in FY14 to just 21% in FY20. Both of the lower income subsets have experienced good growth over the past 6 years. It’s great that Peloton’s income demographics are becoming more diversified, but the company still maintains the vast majority of their customer base in high earners. Peloton could make a big entrance into the under 50k subset by producing an even cheaper model, but a more likely approach is through their Digital Subscription Service priced at $12.99/mo with no Peloton equipment required.  

Peloton demographic

According to Peloton’s research, there are 52 million households that “express interest in learning more about at least one Peloton product without seeing price.” When it comes to households interested in purchasing a Peloton product at the current price, Peloton estimates the market at 20 million households. With Peloton recently reporting 2.08 connected fitness subscriptions in Q3 FY2021, Peloton has massive untapped Served Available Market (SAM).

Competetive Advantage

Peloton’s competitors include NordicTrack, Echelon, Equinox, Lululemon, and Apple to name a few. NordicTrack and Echelon compete with Peloton in both connected fitness products and fitness streaming, selling at cheaper prices and appealing to value consumers. On the other hand, Equinox, Lululemon, and Apple mainly compete with Peloton in fitness streaming platforms.

However, even among this competition, Peloton’s moat is wider than most think.

Their competitive advantage can be split into three main parts:

  • Brand
  • Community
  • Vertical Integration

Peloton was one of the first in the market of live online fitness classes, and have since built themselves as the leader. This position comes with an increased sense of trust and security for consumers – going with what they already know is legit and works. Peloton has a more powerful brand than its competitors NordicTrack and Echelon in the connected fitness products industry – out of a lot of friends and family: everyone was familiar with Peloton, few with NordicTrack, and none with Echelon. Peloton can use its current brand superiority and market leading position to keep competitors at bay. With regards to streaming, I think of it like Spotify. Sure Apple Music and a bunch of other players came into the music streaming industry, but Spotify remains the global leader with an intact 33% market share, while Apple saw slight declines in market share during the same time period. Apple has come into fitness streaming as well (at this point it’s almost everywhere) with Fitness+, and it’ll likely gain some serious market share, but similar to the Spotify situation, I doubt Apple Fitness+ will dethrone Peloton as the #1 online fitness platform.

In addition, the Peloton community is very sticky. Peloton has built their platform with social interactions in mind. Every step of the way, there is an opportunity to share with friends, on social media, and be on a journey together with others. In 2020, 248 million high fives were sent, and over 100,000 tags have been created by members in total. Peloton user engagement continues to balloon as Connected Fitness Workouts hit 149.5 million in Q3 FY21 (239% Y/Y) and Average Monthly Workouts Per Connected Fitness Subscriber hit 26.0 (46.9% Y/Y). A highly engaging platform is a sticky one that’s hard to leave for a competitor – and this is shown by Peloton’s extremely low Net Monthly Connected Fitness Churn of 0.31% in Q3 FY21, with a 12-month retention rate of 92%.

Peloton engagement

Peloton’s avid user base is comparable to enthusiasts of Apple or Tesla. Members have favorite instructors, workout with friends, share rides on social media, and LOVE to talk about Peloton. Their membership base is the type to convince friends to get involved (especially with the social aspects of Peloton’s platform) and argue why Pelotons are the best to buy. This community, along with phenomenal engagement metrics, provide a moat that isn’t so easy to breach.

Lastly, Peloton’s move toward vertical integration separates it from competitors. Vertical integration means more control, efficient supply chains, and lower costs. Peloton has heavily invested in hardware, software, media, retail, and logistics to provide a fully integrated experience. In late 2019 Peloton acquired Tonic in a ~$50 million deal, greatly increasing manufacturing capabilities in Taiwan. And more recently on April 1st 2021, Peloton completed its acquisition of Precor: a major fitness equipment manufacturer in the US for just $420 million as the business got crushed by the COVID-19 pandemic. This establishes US manufacturing capacity and helps alleviate supply constraints. Peloton is further tightening integration with in-house software production and home delivery employees, rather than outsourcing the work. As a whole, Peloton’s vertical integration coming together now gives them a massive advantage over competitors to scale deliveries and features for a large and ever-growing number of users.

And so in conclusion, despite fierce competition, I stand to believe that Peloton will maintain itself as the leader in connected fitness products and fitness streaming.

Opportunities

In the foreseeable future, there are two main growth opportunities Peloton can capitalize on:

  • International Expansion (Europe, Asia Pacific)
  • Treadmill Expansion (<5% of revenue currently)

Peloton has already started going in the right direction. In terms of International Expansion, Peloton announced on March 8th its expansion of Bike, Bike+, and the Peloton App to Australia, the company’s first entrance into the Asia Pacific market. However, there is tons more growth opportunity here. Peloton currently only ships Bikes to the US, UK, Germany, some parts of Canada, and soon to be Australia in the second half of 2021. Meanwhile Treads currently only ship to the US, though there are plans to expand into the UK, Canada, and Germany. There are multitudes of wealthy people across the world who would be interested in Peloton’s products, and expanding globally, specifically in the Asia Pacific (China, Japan, South Korea, Singapore, etc) and unexplored regions of Europe (France, Netherlands, Norway, etc) would increase TAM by massive amounts. Management plans for geographic expansion in a “deliberate and disciplined approach”, which may ramp up once supply chain issues ease and manufacturing capacity increases.

Peloton Q3 2021 Geographic Expansion

Secondly, with treadmills, Peloton offers the Tread and Tread+ products, though sales have halted temporarily (expected to last until June according to management) due to safety concerns and the ongoing recall. Before the recall, treadmills only made up a sliver of Peloton’s revenue – and that has a lot of room to grow. Peloton allocates the vast majority of ad spending towards the bike, but going forward, Peloton says “we expect Tread SAM to grow significantly as we market new Tread in FY 2021.” In addition, the fitness treadmill market is much larger as a whole in comparison to the fitness bike market. If Peloton plays their cards right with revised, safety-improved Tread models in the summer of 2021, they could latch onto a huge potential market.

On top of both international expansion and treadmill expansion to grow the underlying business, Peloton also has opportunities in creating other connected fitness products (rowers, mirrors, etc) and expanding their digital subscription memberships. Peloton maintains a high priority towards subscription growth, stating “we will prioritize connected fitness subscription growth over profitability.” Meanwhile in other opportunities regarding connected fitness products, we likely won’t see Peloton expanding there until a successful re-entry and expansion of their Tread & Tread+ lineup has been completed.

Overall, Peloton is only slightly penetrated in a large TAM – and their numerous growth opportunities can keep them growing by sizeable amounts for years to come.

Risks

Over the last few months and through Peloton’s big plummet in stock price, investors have voiced multiple concerns about the company. As is with any investment, Peloton comes with a degree of risk.

Risks/problems include:

  • Lower demand and revenue growth as the economy reopens
  • Competition eroding market share and revenue growth
  • Supply chain issues leading to slower equipment deliveries
  • Initial CSPC response causing reputation damage
  • Tread recall related expenses and delays

A decision to buy Peloton stock depends on if you think the company can overcome these short-term challenges, and continue to grow and be the leader in connected fitness/fitness streaming.

Other possible issues moving forward could involve popular instructors leaving or music license disputes, both of which would impact Peloton in a very negative way – instructors and music are two sticking points of the platform.

Financials

Liquidity

Peloton likely won’t have any liquidity issues in the foreseeable future. Current assets minus inventory stand at $3.330B and current liabilities stand at $1.283B as of their most recent earnings report, representing a quick ratio of 2.60, well above a satisfactory level of 1. On top of this, Peloton has a whopping $2.056B cash on hand – which would be plenty enough to cover any unexpected short-term hurdles.

Metric Value
Current Assets
$3,514B
Inventory
$0.184B
Current Liabilities
$1.283B
Current Ratio
2.74
Quick Ratio
2.60

Debt

Peloton’s debt used to be at 0 until February 21st when the company completed a $1.0B offering of 0% Convertible Senior Notes due in 2026. In the most recent quarter, Peloton reported $821.5M of this on the balance sheet. The cash can help Peloton pursue acquisitions and fund growth opportunities, but it means increased dilution moving forward.

Nonetheless, the debt represents a fraction of equity and cash in hand.

Metric Value
Convertible Senior Notes
$0.822B
Stockholders' Equity
$1.993B
Cash and Equivalents
$2.056B
Debt/Equity
0.41
Debt/Cash
0.40

In addition, interest expense is close to nothing, and the new notes have been issued at a 0% rate – making this a nonconcern.

Profitability

Peloton most recently reported gross margins of 35.2%, down significantly compared to margins of 46.9% in Q3 FY20. This was brought down by a 1,593 basis point decline in connected fitness gross margins from 44.3% to 28.4% YoY. Meanwhile subscription margins rose to 64.6% from 57.8% YoY.

Metric Q3 FY21 Q3 FY20
Total Gross Margin
35.2%
46.9%
Connected Fitness GM
28.4%
44.3%
Subscription GM
64.6%
57.8%

However, the picture isn’t as bad as it seems. According to Peloton, connected fitness gross profit was “primarily impacted by expedited shipping investments, the September 2020 Peloton Bike price reduction, and a modest mix shift of sales to our treadmill products.” I’d expect margins here to rise long-term as one time shipping investments disappear and operations, especially with the tread, become increasingly efficient with scale and integration.

Subscription margins rose as fixed costs related to content production made up less of total subscription revenue. I’d expect margins to rise long-term here as well with more users and revenue.

Despite the hiccup this quarter, margins may normalize to the low-mid 40s going forward (high 30s connected fitness GM + high 60s subscription GM).

In terms of comparison, there is no easy competitor to pick out as almost all are private.

Comparing Peloton’s TTM gross margin to the other fitness players Nike and Lululemon, its lower than Nike’s gross margin and significantly lower than Lululemon’s gross margin.

Company Gross Margin (TTM)
Peloton
40.3%
Nike
43.3%
Lululemon
56.0%

But in my opinion, despite not being in the fitness industry, Roku is a better comparison for margins. Roku runs a very similar business model as Peloton – sell a physical product and then an attached subscription service.

Company Gross Margin (TTM)
Peloton
40.3%
Roku
48.9%

The number is lower, but this type of comparison still remains unmeaningful when there is no direct public competitor like Echelon since higher/lower gross margins does not show relative production efficiency.

Valuation

Peloton is a growth stock that is yet to post consistent profits. Thus, valuation metrics surrounding earnings would not make sense. Rather, the best approach is to use a Enterprise Value by Gross Profit (EV/GP) multiple.

Many investors like to use the Price/Sales for growth stocks, but this is not very useful (by itself or in peer comparisons) since there is no accounting for profitability. Instead, by using gross profit, there is some level of profitability taken into account when an earnings number is not appropriate. In addition, using Enterprise Value over price will allow us to factor in debt/cash that would be paid/received respectively in an acquisition.

With valuation, comparison is key to understanding relative valuation in the market – and with Peloton we again come with the problem of not having any easy competitors in the public stock market to compare to. The next best option is a comparison to other stay at home / high growth stocks that are bought by similar investors as those of Peloton.

In the following analysis, we’ll compare valuations against:

  • Teladoc
  • DocuSign
  • Roku
  • Pinterest
  • Lululemon
  • Zoom

Note: Lululemon and Zoom are not as good of comparisons as the first 4 since they have recently become consistently profitable, thus making gross profit an inferior metric to earnings for them.

First, comparing EV/Gross Profit multiples versus revenue growth rate (TTM) and expected growth rates for the next 3 years.

Company EV/Gross Profit 3y Forward Avg. Rev. CAGR TTM Rev. CAGR
Peloton
15.80
30.11%
140.67%
Teledoc
26.57
38.23%
150.93%
DocuSign
35.03
31.98%
56.73%
Roku
40.23
35.72%
79.00%
Pinterest
26.17
36.04%
78.43%
Lululemon
17.70
16.23%
29.31%
Zoom
46.31
22.69%
395.54%

In this comparison, the EV/GP multiples and expected growth rates are most important as previous growth is already accounted in the multiple. Peloton looks the most attractive with an EV/Gross Profit less than 16 and expected revenue growth greater than 30% – despite analyst revisions downward due to recent events. Teladoc and Pinterest seem the most competitive in terms of valuation, with Roku and Zoom seeming overvalued. 

Now by looking at EV by Gross Profit 3 years down the road (estimated using revenue growth and current gross margins), this can give us a better picture of valuation in just 1 number.

Company EV/Gross Profit EV/3y Fwd. Gross Profit
Peloton
15.80
7.17
Teledoc
26.57
10.99
DocuSign
35.03
15.24
Roku
40.23
16.51
Pinterest
26.17
11.70
Lululemon
17.70
10.63
Zoom
46.31
25.07

Peloton remains the cheapest by a good amount, standing at 7.17 EV/3y Fwd. Gross Profit – despite a hit to profit margins this year due to one time shipping expenses. The next cheapest stocks Lululemon, Teladoc, and Pinterest trade at 10.63, 10.99, and 11.70 times 3y Fwd. Gross Profit respectively.

Lastly, we can look at historical EV/sales to compare Peloton’s valuation to previous time periods. As of 5/9/21, Peloton trades at an EV/sales of about 6.7, below a historical average of 9 (7.5 excluding the October/January spikes).

Overall, Peloton is trading at a very attractive valuation of 15.8x GP with 30% expected growth moving forward. This growth makes sense considering opportunities in geographic expansion, the treadmill market, and more. Value Line equity analyst Kevin O’Sullivan estimates $11.5B in Revenue, $3.00 in EPS, $3.45 in Free Cash Flow, and 12% operating margins for 2025.

Conclusion

In my opinion, Peloton is a great company trading at a juicy discount following recent events.

However, a number of risks loom. You should not purchase Peloton stock if:

  • You believe Peloton cannot grow in the high 20s to low 30s range for the next few years 
  • You believe competitors will steal significant market share from Peloton moving forward
  • You believe supply chain issues, CSPC refutes, Tread recalls, and other short-term issues will have a significant impact on Peloton’s reputation, market share, and/or revenue
  • You believe music licensing and instructor issues will hurt Peloton significantly long-term

Despite the risks, I remain bullish on Peloton long-term. Equipment delivery times have returned to pre-pandemic levels, and increased media attention relating to CSPC events may partially offset recall costs. On the growth front, I believe Peloton can sustain high growth numbers for the coming years with its numerous opportunities and large TAM. And lastly, on the competition front, I believe Pelotons brand, community, and vertical integration will shield market share for the foreseeable future.

Thus, I have been buying Peloton stock during the dip and plan to continue doing so when the price is below $110 and especially when its below $100 – at which points the price gives me a good margin of safety.

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Disclaimer: Opinions not advice! I own shares in Peloton stock. I am not a registered financial advisor. All views and recommendations expressed in this article are solely my opinions and should not be considered as financial advice.