2021 was a rough year for Peloton Interactive (NASDAQ: PTON), with shares falling 77.4% from their highs early in the year. Not only did people start going back to work, reducing demand for Peloton's bikes, but the company also had a high-profile recall of its treadmill, and financial results suffered as the year went on.
Shares are now approaching their pre-pandemic levels -- but since the pandemic began Peloton has more than tripled its subscriber numbers, which is why investors loved this growth stock in the first place. I think there's something missing in investors' view of this company, and long-term it's still a great buy.
The real story behind Peloton
Peloton's business really has two sides. There's the hardware business that sells bikes, treadmills, shoes, and more. This should be slightly better than a breakeven business long-term, and it fuels the larger business, but it's not where the company's real value lies.
The greater value comes from fitness subscriptions, or people who pay each month to access Peloton's streaming workout content. The user base of subscribers, and ultimately subscriber revenue, is what we want to see grow long-term, because it should be a high-margin business for the company.
The challenge in 2021 is that hardware sales, which are bigger numbers than streaming subscriptions, fell hard, overshadowing its strength in the subscription business.
Hardware sales, which Peloton calls connected fitness revenue, peaked in the first quarter of 2021 at $1.03 billion, which was up 140% from a year earlier. But the market saw trouble coming, and that played out with connected fitness revenue falling to $501.0 million in the third calendar quarter of the year.
Over the same timeframe, gross profit from connected fitness fell from $290.4 million to $60.0 million. This was partly due to fewer sales, but exacerbated by price reductions.
Subscriptions are still going strong
Hardware sales may be down, but let's not forget that millions of people now have Peloton bikes in their homes. And from the fiscal second quarter of 2020 (calendar Q4 2019) to the most recent quarter, the company's subscriber number has grown from 712,000 to 2.49 million. Last quarter, subscription revenue was $304.1 million, up 94% from a year ago, and gross profit of $202.7 million was 66.7% of revenue.
Like any gym, Peloton's business is sticky. Once subscriptions are started they're hard to turn off, and that's proving true for the high-margin part of Peloton's business.
Where Peloton has to prove itself
I think the biggest flaw in Peloton's business today is its high operating costs. In the most recent quarter the company spent $622.4 million on operations, including $284.3 million on sales and marketing. The margin from hardware and subscription sales has to cover operating costs, and either Peloton has to cut back spending or increase margins in other parts of the business.
High spending and losses are expected to continue, with adjusted EBITDA guidance for the current quarter at a loss of $325 million to $350 million. For the full fiscal 2021, which ends in June of 2022, adjusted EBITDA loss is expected to be $425 million to $475 million. But management did say that in fiscal 2023 they expect to be profitable on an adjusted EBITDA basis.
Adjusting to the new reality
Peloton grew far faster than expected during the pandemic, and is now adjusting to a more "normal" business cycle. That's leading to losses short-term, but I think Peloton can return to profitability as subscriber numbers slowly grow. It's a great brand with a great product and a reasonable valuation at a forward price-to-sale ratio of about 2.5 times, the lowest since it went public.
If management can keep operating costs under control, I think Peloton stock is compelling. This is a great subscription service with an improving suite of workouts and hardware that should benefit from the growth in people working from home long-term. That's a long-term growth stock I can bet on for 2022 and beyond.
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