Peloton inventory is reasonable given its stable subscription enterprise

Close-up of the logo for Peloton on the exercise bike, San Francisco, California, June 14, 2021. (Photo … [+] Smith Collection/Gado/Getty Images)

Gado via Getty Images

Peloton’s stock saw another sell-off, falling around 40% over the last month as rising inflation, rising interest rates and the prospect of a recession continued to steer investors away from growth stocks and pandemic favorites. Additionally, Peloton’s earnings for the third quarter of FY22 were weaker than expected, with revenue falling to $964.3 million from $1.26 billion a year earlier as demand for home fitness equipment declined significantly . This was Peloton’s first year-over-year revenue decline since its IPO. Peloton’s poor planning didn’t help either, as inventories piled up and weighed on the company’s cash while sales fell. Net losses also increased to $2.27 per share from about $0.03 a year earlier. Things are expected to remain difficult in Q4 FY22 as the company is forecasting revenue of between $675 million and $700 million, well below consensus estimates, down as much as 29% from the year-ago quarter is equivalent to.

With the recent sell-off, Peloton stock now remains about 85% below its all-time highs and about 60% from last year. While it’s probably ill advised not to anchor to all-time highs for stocks like Peloton, which has seen rising demand during the Covid-19 pandemic, likely a one-off event, we think the risk of reward positioning for Peloton stocks is very cheap at current levels of around $14 per share.

Peloton’s lucrative subscription business has continued to grow despite recent headwinds. In the third quarter, subscription revenue grew 54% year over year to $370 million, with subscription gross margins increasing 350 basis points to 68.1%. Peloton’s base of connected fitness subscribers — who pay for classes synced to their Peloton devices — increased 40% to 2.96 million, although quarterly net adds fell significantly. Peloton’s core customer base also appears to be very loyal, with churn rates as low as 0.75%. Peloton believes it has the pricing power here, as affiliated fitness fees will increase from $39 per month to $44 per month in July. Peloton’s hardware business is more of a gateway to the more lucrative subscriptions, and Peloton now seems willing to forego some hardware-related upfront revenue in favor of more content and subscription sales. For example, the company recently reduced the price of its original bike by $300 to $1,195, with the Bike+ price dropping by $500 to $1,995. Even the company’s new Guide strength-training machine went on sale for less than an expected $295.

Regardless, as travel and gym memberships pick up again post-Covid, Peloton could see some upside from acquiring fitness equipment maker Precor and its commercial facility deals. Peloton’s market cap is currently close to $5 billion, making the company an acquisition target for larger tech or lifestyle companies like Apple AAPL, Amazon AMZN, or even Nike NKE. Peloton’s valuation is also compelling. The stock now trades at just under 1.4 times consensus 2022 earnings, up from over 6 times pre-pandemic. There remains a real prospect that it could be valued higher, as subscription revenue makes up a larger revenue mix. For example, subscription revenue accounted for nearly 39% of total revenue in the third quarter, up from just 19% a year earlier.

We estimate Peloton rating around $30 per share, which is well above the current market price. Check out our analysis Peloton Earnings: How does Peloton make money for a closer look at Peloton’s business model, key revenue streams, and how they’ve evolved.

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