Peloton Interactive (PTON, Financial) operates an interactive fitness platform via two business segments: Connected Fitness Products and Subscription. The company is well known for offering indoor cycling classes both live and on-demand, and its suite of products includes the Peloton Bike, treads, rows, apparel, accessories and an app that offers thousands of classes for exercising, from pilates and yoga to running, walking and building strength.
Among investors, it's best known for its boom and bust during the pandemic. Many have been eyeing the stock as a potential value opportunity as its share price has fallen. However, I don't think a recovery is in the cards. Peloton shares are up nearly 9.50% year-to-date, but I see a lot of fundamental problems in Peloton’s business model, as well as a historic missed opportunity that should concern investors a lot.
The bursting of the bubble and how Peloton mishandled it
The Covid-19 pandemic brought some trends like working and exercising at home, and this favored a particular category of stocks, nicknamed "pandemic stocks."
In 2019, 2020 and into the early part of 2021, Peloton had very strong sales growth that was boosted by the pandemic, as it reported growth of 110.30%, 99.55% and 120.26% in those years, respectively. Even with this huge opportunity, Peloton never managed to be profitable over those three years, which was a big mistake in my opinion. It was positioning itself for pandemic growth to continue forever, when it should have been bracing for an imminent correction.
Things seem to have become worse as in 2022 Peloton reported a decline of 10.93% in sales to $3.58 billion and a huge widening net loss of $2.83 billion compared to a net loss of $189 million for 2021. A closer look at the profitability trend shows that Peloton has been losing money for all previous five consecutive years.
Now to be fair, it is not 100% certain that a surge in revenue will bring profitability, but it generally makes it possible depending on what the management is spending the revenue on. Sometimes the company is spending all its revenue just to make the products to generate more revenue, which is not sustainable anyway.
A downgrade for Peloton shows reluctance in analysts' faith
In June, an analyst firm I follow, Wolfe Research LLC, downgraded the company to a sell-equivalent rating, saying its “path to growth doesn’t seem to exist.” Looking at the report, it was like the analyst read my worries about the pandemic effects on the company. He stated that he “expects demand for at-home fitness products to remain muted after the pandemic pulled forward interest," and he "has limited confidence in the company’s new growth initiatives, including its fitness-as-a-service rental program and third-party distribution. In addition, the path to sustainable profitability and free cash flow is unclear."
Fundamentals and valuation
Peloton shares trade at a price-sales ratio of 1.08. The GF Value chart suggests a possible value trap.
One warning sign is a rise in building inventory, which is not good as it could mean Peloton may face difficulties selling its goods. The Piotroski F-Score of 1 out of 9 is very low, which implies very poor business operational performance.
Peloton has a gross margin that has been in long-term decline, with the average rate of decline per year being -8.8% since the company went public. It should be noted that Peloton’s gross margin is ranked worse than 74.9% of 761 companies in its industry.
The Altman Z-score of -2.57 is in the distress zone, implying bankruptcy possibility in the next two years.
While the three-year revenue per share growth rate of 50% is eye-catching, Peloton is not generating positive free cash flow. In 2021, the company reported free cash flow of -$472.7 million, and in 2022, there was a significant deterioration with free cash flow of -$2.3 billion.
What Peloton needs to do now is to find a way to reshape its business model as it is massively unprofitable. However, it missed the opportunity to do this wile pandemic business was booming This fitness company has too much work to do to put its financials into good shape.
