Headquartered in New York, Peloton Interactive (PTON) provides interactive fitness products. I am neutral on the stock.
It seems like ages ago now, but in 2020, the COVID-19 crisis made Peloton a superstar on Wall Street for a while. Widespread lockdowns meant that people had to exercise at home instead of going out to gyms. Peloton was a right-place, right-time business, it seemed.
The circumstances have changed dramatically during the past couple of years, though. Lockdowns have largely been lifted in the U.S., and people are venturing out to fitness centers throughout the nation. Plus, Peloton is facing the same challenges as many other firms are facing in 2022, including inflation and supply-chain issues.
As a result, the company has to prove its viability as a business. Investors facing severe share-price drawdowns aren’t going to wait forever for Peloton to improve its financials. As we’ll see, it appears that the company is taking action, but it might not be the right action, as Peloton doesn’t need a huge debt load. Ultimately, prospective investors ought to watch and wait to see what Peloton does next and whether it’s constructive or destructive.
After the Mania
At the peak of the hype phase, Peloton stock traded in the $170s. That’s almost unimaginable now as the share price recently fell to $12 and change. So, are prospective traders looking at the bargain of a lifetime or just a value trap?
One expert, at least, seems to lean bearish on the industry in which Peloton operates. Indeed, Craig-Hallum analyst Steve Dyer appears to be bracing for a rocky road ahead, stating that “the at-home fitness industry is now in a normalization mode following mania in 2020/2021. Demand is softening, cost inflation increasing, and competitive headwinds intensifying.”
Dyer further suggested that “business fundamentals will be challenged in the near term” for companies in this niche market. This, of course, doesn’t bode well for Peloton and its stock.
Furthermore, Peloton’s most recently released quarterly data tends to support Dyer’s risk-off stance. This isn’t to suggest, though, that Peloton isn’t able to maintain its membership. In actuality, Peloton grew its membership base 29% year-over-year during Q3 of FY2022. With a total of seven million members, you’d think that Peloton is in full turnaround mode, right?
Not necessarily. We’ve already observed how far the Peloton share price has fallen. Clearly, investors aren’t moved by the company’s recent membership growth. There must be deeper issues within the company.
It’s not hard to find those issues. For one thing, Peloton’s Q3 FY2022 revenue declined 24% year-over-year. When a company’s membership is growing, but the revenue is declining, something’s definitely amiss.
More Money, but Not Free Money
If Peloton’s top-line result was bad, then the company’s bottom-line results were even worse. From the year-earlier quarter to Q3 FY2022, Peloton went from an $8.6 million net loss to a horrendous $757.1 million loss. Moreover, the company swung from a positive adjusted EBITDA of $63.2 million to a negative adjusted EBITDA of $194.0 million.
What happened here? Peloton cited reduced revenue as a primary driver of bottom-line declines, along with a lower Connected Fitness gross margin and higher operating expenses. Pertaining to the higher expenses, Peloton mentioned that the most-recently-reported quarter’s “total operating expense was $920 million, and grew 101% year-over-year.” So, some cost-cutting measures would certainly be justified at this point.
A related topic is Peloton’s free cash flow, which was negative to the tune of $746.7 million. The company characterized this unfortunate result as a “higher outflow than anticipated,” which surely won’t provide much comfort to Peloton’s shareholders.
On top of all that, Peloton CEO and President Barry McCarthy conceded that his company finished the third fiscal quarter “thinly capitalized for a business of our scale.” In light of this, investors should ask themselves whether Peloton is a business that they can hold shares of with confidence for the long term.
Perhaps to address its financial issues, Peloton signed a binding commitment letter to borrow $750 million in five-year term debt from a couple of large financial institutions.
It’s been reported that the sale of this five-year debt was completed successfully and that the effective yield of the loans exceeded 8% at issuance and is subject to change. In other words, don’t just assume that this represents anything more than temporary relief from Peloton’s financial problems. The company will have to pay the $750 million back – with interest.
Wall Street’s Take
Turning to Wall Street, PTON comes in as a Moderate Buy based on 15 Buys, 10 Holds, and two Sell ratings assigned in the past three months. The average Peloton Interactive price target is $22.58, implying 85.2% upside potential.
The Takeaway
A $750 million capital infusion could certainly help Peloton in the short term, but it won’t likely solve the company’s deepest issues. Investors should want to see Peloton implement major cost-cutting measures while getting creative in finding ways to ramp up the company’s revenue. Until there’s evidence of this in upcoming financial reports, Peloton stock is a no-go.
