Up 44% in 2023, Is the Worst Over for Peloton Inventory?

peloton (PTON 3.16%) was an investor favorite during the COVID-19 stock market bubble. Now, with the pandemic in the rearview mirror, an abrupt exit from founder/CEO John Foley, and the air coming out of the bubble, Peloton stock has plummeted. The stock is down 60% over the past year, and significantly more since its peak in early 2021, when the company started bleeding money and losing demand for its at-home fitness products.

But this year, Peloton stock has started a comeback, up a whopping 44% so far in January. Does that mean the worst is over for Peloton shareholders? Let’s investigate

Recent Developments

When John Foley left Peloton, a renowned manager left Netflix and Spotify named Barry McCarthy took the helm as CEO. And Foley left him quite a mess to clean up. Peloton drastically miscalculated consumer demand for its exercise equipment in 2022, built up huge amounts of inventory and planned a new manufacturing center called Peloton Output Park in Ohio. It found that fewer people wanted to buy $2,000 exercise bikes when they could get away from home to work out, leading to a huge drop in customer orders in late 2021 and early 2022.

In the first quarter of calendar 2022, Peloton’s hardware revenue declined 42% year over year. This prompted McCarthy to make big changes at Peloton as the company was now burning nearly $750 million a quarter in free cash flow and on its previous financial path would have gone bankrupt sometime last year. These changes included major layoffs of employees, reorganizing the supply chain to rely much more on third-party partners (which reduced fixed costs), and taking on debt to shore up liquidity during this crisis.

The company has since reversed that cash burn somewhat, burning “only” $246 million in its most recent quarter. Affiliated fitness subscribers — who pay high-margin subscription revenue each month — continued to grow, reaching nearly 3 million by the end of September, while management also forged distribution partnerships Amazon and Dick’s sporting goods and launched a rowing machine called the Peloton Row. The company is still in terrible shape, but McCarthy has started making some improvements in about a year as the new leader of Peloton.

Why the worst is yet to come

Famed investor Warren Buffett has often been quoted as saying that it doesn’t matter how smart an executive is — they can’t magically turn a terrible deal into a good one. I think that’s what’s happening at Peloton today.

The company is still burning around $1 billion in cash a year at its current run rate. Sure, McCarthy and the new leadership team have a solid subscription business, but that subscriber base needs to grow significantly over the next few years to be cash flow positive.

Peloton’s total gross income last quarter was just $217 million, which barely covers its $194 million in quarterly administrative expenses, not to mention large marketing and product development expenses. Connected Fitness subscriptions are forecast to only grow from 2.97 million to 3 million this quarter, which I think suggests that this rapid subscriber growth isn’t happening anytime soon, leaving the company in a state of disrepair of burning money remains.

PTON Free Cash Flow (Quarterly) data by YCharts

With a market cap of $3.75 billion, some investors might think there’s value in buying Peloton stock today. But there is no price low enough for a business that is structurally unviable. Stay away from Peloton stocks unless the company starts generating steady cash flow.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Brett Schafer has positions in Spotify Technology. The Motley Fool has positions in and recommends Amazon.com, Netflix, Peloton Interactive, and Spotify Technology. The Motley Fool has a disclosure policy.

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