Peloton Might Finally Be Going Places

Andrew Rummer

5 months ago4:53 mins

Peloton Might Finally Be Going Places

Peloton investors have faced an endurance test to rival the fitness firm’s toughest workouts over the past year. But after an 85% downhill run in the share price, the worst might finally be behind them. And that might make now a good time to buy into the company…

What’s been going on with Peloton?

Following a bumpy market debut in September 2019, Peloton’s life as a public company quickly settled into a steady groove. That is, until the coronavirus pandemic upended consumer habits and convinced investors that the future of fitness was home-bound.

Peloton’s stock surged from a low of less than $20 a share in March 2020 to $167 in January 2021, driving its market value to nearly $50 billion. Since then, however, it’s been downhill all the way: the stock closed at $24.75 on Wednesday, within a dollar of where it closed on its first day as a public company two and a half years ago.

But while lockdown demand no doubt helped drive Peloton’s sales – with revenue forecast to hit $4.3 billion this year versus $915 million in 2019 – the macro picture has had at least as much impact on the share price. After all, Peloton’s performance since its initial public offering (IPO) has followed the Goldman Sachs index of unprofitable tech, as investors continued their on-again-off-again romance with fast-growing companies that were yet to break even.

Peloton versus the Goldman Sachs index of unprofitable tech stocks
Peloton versus the Goldman Sachs index of unprofitable tech stocks

Why have investors turned on Peloton?

The heart of Peloton’s troubles stem from its mix of hardware and software sales. Over the past four years, selling static bikes and other fancy exercise equipment has consistently made up about 80% of revenue, with the remaining 20% or so coming from subscriptions to its suite of online workouts.

And while profit margins on that smaller chunk of subscription revenue have been growing, margins on its hardware products have been falling as the company cuts prices.

Peloton margins

With that backdrop, a report last week that Peloton was pausing production of exercise bikes and treadmills after demand failed to match its projections understandably sent its shares tumbling to a fresh low.

The question is whether Peloton – which had 2.8 million subscribers by the end of 2021 – will ever remotely approach the 14 million subscribers it aspired to in its pre-IPO filings, or whether the company is already topping out the global market for high-end home workouts.

Peloton’s August 2019 estimates of total market size
Peloton’s August 2019 estimates of total market size

What’s Peloton’s next play?

To secure its future, Peloton needs to chart a course to maintain growth even as the pandemic recedes. And to do that it probably needs to expand beyond its core, cardio-focused bike and treadmill products.

It’s already made a start, launching a strength training camera called Guide in November. According to Bloomberg Intelligence, strength-focused classes are the biggest fitness category outside of cycling, with a 15% share of workouts. But there are already established competitors in the space, like Lululemon’s Mirror.

To more swiftly pivot away from its cardio-only reputation, I wouldn’t be surprised to see Peloton making approaches for strength-focused fitness startups like Tonal, Tempo, or Frame.

But equally, Peloton’s future may be as acquired rather than acquirer. Plenty of observers are making noises that – at a valuation of $8 billion – Peloton would be an attractive way for giants like Apple, Alphabet, or Nike to quickly bulk up their own connected fitness offerings.

That might mean Peloton follows the trail laid out by Fitbit. The maker of fitness-tracking watches hit the stock market with a $4 billion valuation in 2015 and soared to nearly $11 billion within two months – before beginning a steady decline that ended with its acquisition by Alphabet’s Google for $2.1 billion.

That possibility puts a floor under Peloton’s valuation, but its shares might need to fall a little further to really tempt potential acquirers out of the woodwork. Google paid about 1x revenue when it announced the purchase of Fitbit in 2019 – roughly half Peloton’s current valuation.

For its part, Peloton is for now focused on reviewing its costs – despite calls this week from activist investors to explore a sale.

So should you invest in Peloton?

If you liked Peloton when it hit the stock market in 2019 at $29, it’s surely more attractive now at less than $25. After all, what was a niche luxury product – which Peloton itself admitted had “low brand awareness” outside the US – is now a household name across much of the world.

And while the company’s still to make a profit, its growing revenue has pulled down its valuation to reasonable levels. Peloton’s currently trading with an enterprise value (EV) of about 1.8x forecast 2023 sales, compared to an average of 4.2x for rivals in the fitness sector.

Some Wall Street analysts are starting to see value in Peloton at current levels too. Stifel wrote last week that the stock “has over-corrected relative to underlying business conditions” and upgraded its rating from hold to buy – even while cutting its price target to $40 from $56.

As a block, Wall Street started very bullish on Peloton, with near-universal buy ratings as the stock surged in 2020. Now just 16 of 30 analysts tracked by Bloomberg rate it a buy – although Stifel’s upgrade has led to the first ever uptick in the average recommendation.

Peloton share price in green and average analyst rating in blue
Peloton share price in green and average analyst rating in blue

So Peloton’s worst days appear to be behind it. The company may be able to execute a successful expansion into new fitness products, cut costs, and eventually achieve profitability. Or it may slide a little further and become an irresistible takeover target for a bigger player in the digital fitness sector.

Taking a little punt on Peloton at these levels certainly feels less risky than for most of 2020 and 2021. But I don’t see a way for Peloton to return to those heady days of a $50 billion valuation. Even at the time that seemed implausible, and with 2022 hindsight it seems pure folly.

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