Peloton: Difficult Terrain & Headwinds Ahead

Once the darling of lockdown, way back in 2020, Peloton (NASDAQ:PTON) has spent the last few years battling a blistering headwind. Where once it was careering to new highs at breakneck speed, it has since skidded down the other side, crashing in a heap at the bottom of the mountain. In fact, the fall in the company’s share price is more akin to jumping off the top of Everest: the shares are down a whopping 94% since early 2021.

Q1 of FY23 saw Peloton record a net loss of over $400m. This comes after a FY22 net loss of close to $3bn. What’s more the company has never actually recorded a profit in it’s four years as a public company. It’s market capitalisation now sits at a somewhat paltry $3bn. But even that doesn’t exactly seem cheap.

As expected – given these losses – Peloton is aggressively trying to cut costs wherever it can. Free cash flow has improved from -$652m in Q1 of FY22 to -$246m in Q1 FY23. From a cost and free cash flow point of view, it’s clear that things are moving in the right direction. But whether they can go far enough is the big question. The latest results show that there is still a heck of a long way to go.

One of the core problems of the company is that its connected fitness products are loss making at even the gross level. The subscription business is much more profitable, but it relies on the products business in the first place. Without products there is no subscription business, making the products business a sort of loss leader. But it’s a very expensive strategy, that as of yet has not paid off.

In professional cycling, the peloton sustains itself in a washing-machine like motion, with riders at the back coming forward to bring fresh impetus and dynamism, keeping the speed going. Likewise, Peloton the company requires constant product innovation, to entice new customers and satisfy the ones it already has. But this innovation ultimately costs money, and lots of it. Therein lies the risk: constant cost cutting will eventually affect innovation and consequently revenue growth.

And here is the big worry for Peloton. Revenue is actually falling. Q1 FY23 revenue was down 23% year on year and 10% from the previous quarter. It’s the connected fitness products division that’s suffering, with sales down a huge 59% year on year. The subscription business is doing well, but not well enough to make up for that kind of damage.

Peloton rode the wave of lockdown-induced home workouts, but now it’s starting to run out of gas. Customers are fed up of staying in their homes, they want to get out and exercise with other human beings, in the flesh. Fitness is now competing with other entertainment options too, like going to restaurants and shopping. To top things off, the economy has entered a tightening cycle, disposable incomes are shrinking and inflation is rising. All in all, the future does not look too bright for Peloton, even taking into account the historically low share price.

The share price is Peloton’s one saving grace. Much of the company’s woes have already been factored into the shares. From a financial point of view, the shares are still expensive, given the huge losses and quickly deteriorating balance sheet. But there is still a speculative element to the shares. There is a chance that Peloton can turn things around. Despite difficult conditions in the overall market, if Peloton can get a handle on costs, then there is certainly scope for some big share price gains. For that reason, the only way I would go anywhere near these shares, is if it was a very small speculative amount that I could afford to lose.