Peloton Interactive: It’s Time To Buy. I Project Profitability (NASDAQ:PTON)
Justin Paget
Peloton Interactive (NASDAQ:PTON) has been on a whirlwind of an adventure over the past few years. As the COVID-19 pandemic drove demand for at-home fitness through the roof, the company saw a huge spike in demand and was barely able to keep up with it.
Then, after the pandemic subsided, they faced the double whammy of having unrealistically high comparative sales, resulting in a significant year-over-year decline, as well as spiked prices for the cost of their products due to inflation, which was a result of ports being closed and goods being stalled.
As a result of that and general market sentiment after reaching a sky-high price of nearly $150 per share, the company’s shares have cratered and sentiment is not changing all that much.
But after I spend a few weeks looking at the nitty-gritty of the company’s fundamentals, earnings, projections, 10-Ks and the likes – I think the market is underestimating what the company’s restructuring efforts will yield.
As a result, I think it’s time to buy Peloton Interactive stock. Let’s dive in.
Headlines – Youza!
Over the past few months, the headlines for the company have been terrible. Multiple downgrades by major investment banks, margin calls on the former CEO as he maintained loans with his stock position as collateral, declining demand for products, big spikes in the cost of materials and delivery hurdles.
And on top of all of that, competitive pressures continue to mount as fitness companies move into the space and try to capitalize off of the increasing hybrid model of work where WFH (work from home) has become more of a norm. And further on top of that, as the world reopens after the pandemic, people are heading back to the gym and as a result, not only are sales of Peloton machines declining, people who previously bought Pelotons are selling them, creating a disincentive for people to buy a new one and rather opt to buy a slightly used one for significantly cheaper.
All of these and more have suppressed the company’s share price.
However…
Behind The Scenes: Revenues
The most interesting thing to me is the company’s focus on their shift to subscription revenues rather than relying on the sales of new fitness products. Given the rather saturated market of fitness machines, it’s hard for them to maintain their already-high name recognition and further boost it to make sales grow at a meaningful way.
Instead, they’re using the fact that so many households have their machines already to create a one stop shop for fitness applications and workout videos and regiments. This is just like Apple (AAPL) uses the fact that so many people use their iPhones already that they can launch multiple billion dollar businesses by introducing various services for those who hold their products.
So what does that look like?
Revenues for the year were down 11% – from $4.02 billion to $3.58 billion. The underlying numbers are what I find fascinating, though.
The company’s product revenues, as in the revenues from the equipment they sold, was down over 30% – from $3.2 billion to $2.2 billion. However, the company’s subscription revenues were 60% – from $872 million to $1.3 billion.
Noteworthy: The company instituted a price increase to subscriptions, from $39 per month to $44 per month, a 12.8% increase, which was factored in.
Revenue Streams Remain Stable
The company has been focusing on driving 2 of their revenue streams by partnering up with companies to sell their equipment, like their recent partnership with DICK’s Sporting Goods (DKS), as well as the previously announced deal with Amazon (AMZN), which has already made some noise with reports of better than expected pre holiday sales.
The company’s subscription services are also getting a big boost by the company’s continued efforts to partner with various organizations which use their subscription services as perks for their employees, resident and the likes. The company added 15 new partners in July of this year and I expect them to announce more of these as the time moves on and companies look for more ways and perks to attract and compensate employees.
As a result of these efforts – the company recently reported that the amount of workouts on the company’s equipment has risen from 460M to 540M, a 17.4% rise, even as total revenues declined 11%.
(Sources: Company 10-K)
Behind The Scenes: Profits
When it comes to the company’s road to profitability, I also have reasons to be optimistic. The company reported a big bump in cost of revenues as raw materials saw a sharp rise all around the world as a result of global inflation.
Cost of Revenues – The Real Story
The cost of revenues for the company usually stands at around 71% but in the most recent reporting year jumped to 111%, resulting in a gross loss for the segment. What bailed out that segment was the subscription revenues, which saw its cost of revenues go from 37.9% to 32.3%.
This was mostly due to the company’s hike in pricing of the service, which didn’t change all that much for the costs associated with producing and paying royalties for the fitness videos put forth by the trainers and others. This price increase took effect on June 1, 2022, which is why I expect the company’s gross margin to expand further in the coming year.
Restructuring Costs, OMG!
In this past full year, the company paid a ridiculous amount for various costs associated with restructuring, which break down as follows:
$182 million in goodwill impairment, $390 million in impairment expenses, $181 in restructuring expenses and $338 million in supplier settlements. This equals to nearly $1.1 billion in one-time charges that resulted in their net income to look so terrible and prompt a lot of their share price decline.
It wasn’t just restructuring costs though, the company’s sales and marketing expenses rose by almost $300 million, their general and administrative expenses rose by just over $300 million and their research and development expenses rose by over $110 million. While a good portion of this is likely to stay, or need to be maintained, in order to facilitate growth, not all of it will.
(Sources: Company 10-K)
That Brings Us To The Buying Part
So, let’s take a look at current expectations and I’ll go over why I think they’re severely underestimating the company’s ability to generate a profit and improve their overall fundamentals.
The company’s revenues are projected to decrease again this coming year:
| 2023 | 2024 | 2025 | |
| Sales | $3.05 billion | $3.41 billion | $3.72 billion |
| Growth | -14.9% | +11.7% | +9.32% |
On those revenue growth figures, analysts currently expect the company to report some strong growth numbers in the EPS department given the aforementioned one-time charges that the company faced in the past year:
| 2023 | 2024 | 2025 | |
| EPS | $(2.22) | $(1.61) | $(1.62) |
| Growth | +52.0% | +27.7% | -0.58% |
(Source: Analyst Projections) (Parenthesis denotes a loss per share)
While the figures here represent a decent view of things given where the company’s headlines are at right now, I don’t believe they reflect a reality of what I’ve talked about throughout the article.
My Expectations – Quite Rosy
For these projections, I am going to use the revenue estimates from the next 3-year period (2026 – 2029), since my investments are geared towards a long term view. Here are those figures based on current expectations:
| 2026 | 2027 | 2028 | |
| EPS | $4.7 billion | $5.4 billion | $5.3 billion |
| Growth | +27.7% | +13.1% | -0.98% |
Revenues
I expect that while the company may not report overwhelming growth to their products and equipment, it will grow by about 2.5% annually, resulting in their 2028 product revenues being around $3 billion, which includes a reversion from the post-pandemic comparison period.
When it comes to their subscription revenues, I expect those figures to grow at a more rapid pace of over 15% annually, which will result in their overall subscription revenues to be around $3.2 billion.
This comes out to their 2029 projected revenues being around $6.2 billion.
Cost Of Revenues
While I don’t expect the costs of raw materials to revert to pre-pandemic levels, I do think that it will revert back significantly and when combined with appropriate price hikes on their products, I expect their cost of revenues to return to a level of around 70% for products and remain steady at around 35% for their subscription revenues.
This means that their gross profit will be $900 million from products and $2.24 billion from subscriptions, for a total gross profit of $3.14 billion.
Various Expenses
While there’s no telling what the company’s debt load and overall need for personnel will be by 2029, I believe we can make conservative assumptions.
Sales and marketing expenses of $1.1 billion.
General and administrative expenses of $1 billion.
Research and development expenses of $400 million.
This results in a total income from operations of $640 million, with another $100 million allocated to various post operations expenses like interest expense and currency fluctuations.
Given that the company has 322.4M shares outstanding, assuming that would increase to about 350M over the next 6 years, that result in a 2029 EPS estimate of $1.54 per share.
(Author Note: The 1 analyst which has estimates out for Peloton for 2029 calls for an EPS of $4.91. While I don’t believe that can happen, it’s noteworthy)
Valuation and Conclusion
As the overall home fitness market is projected to grow at about 5% through 2030, which I believe will continue for the 2030 through 2035 period, a 10x to 15x forward price to earning multiple seems appropriate.
This presents a potential fair value for the company at a range of $15.40 per share to $18.48 per share, meaning that the potential averaged return over the next 6 years can be around 130%.
This return, I believe, will far outperform the broader market and it offers good exposure to a company turnaround which trades at extremely low multiples to potential earnings, as well as a hedge against any form of lockdowns in the future.
I have turned bullish on Peloton Interactive and will be initiating a position.