Leading connected-fitness company Peloton (NASDAQ:PTON) has retreated back almost 40% since hitting an all-time high in January 2021. After its 850%-plus run over a 10-month span, a pullback in PTON stock was due. However, this short-term pullback presents a solid opportunity for long-term investors.
Peloton is particularly enticing when you consider the size of the global fitness industry and the company’s recurring revenue model. I also anticipate a permanent home fitness trend in the new normal. Combined, all of these factors support a narrative where the company might become one of the largest and most popular over the next decade.
Let’s take a closer look at PTON stock.
Peloton and Connected-Fitness
Founded in 2012, Peloton set out to transform the fitness game forever and with the ambition “to empower people to improve their lives through fitness.” It introduced the world to home fitness in a connected way.
Prior to Peloton’s arrival, home fitness was often seen as a lonely, anti-social and unmotivating experience. However, the company flipped that notion on its head. Connected home fitness has proven to hold users accountable through external motivation and incentive-based programs.
The connected-home-fitness trend also solves some of the biggest drawbacks of the traditional gym. A survey by Better reveals some of the biggest reasons people skip the gym are lack of time, lack of confidence, the gym is too busy and childcare needs. Another survey done on 1,000 Americans by Filtrated showed that more than 50% of respondents didn’t go to the gym because they experienced “anxiety or fear of judgment.”
There are other reasons for people avoiding the gym, but the reasons emphasized above are solved by the home fitness trend.
Recurring Revenue Model
The most important aspect of the connected-fitness trend is its recurring revenue component via monthly subscription payments.
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Recurring revenue is a predictable and reliable source of revenue that has strong gross margins (higher gross margins = higher earnings). Over the last 10 quarters, the company has reported 92% or greater growth in its subscription revenue segment with 152.53% year over year (YOY) growth reported in the latest quarter.
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In the latest quarter it also reported 60% gross margins for this revenue segment compared to 35% gross margins in its equipment segment.
“Sticky” Products
Peloton has a fundamentally excellent business model, but even more impressive is the “stickiness” of its products.
The company’s connected-fitness subscriber base has grown 90% or more every quarter for the last 10 quarters. However, churn — the number of subscribers who cancel their membership — has yet to exceed 1%.
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Still, over the last four quarters (Covid-19 duration), the company has more than doubled its subscriber base. Some investors now believe the company’s churn rate may increase in the future.
But I still take the other side of the argument. Prior to the coronavirus pandemic, users never stopped using the bike, so why would new “pandemic subscribers” be any different?
Future Growth
As of quarter end, December 31, 2020, the company had just over 1.6 million subscribers. According to Wellness Creative, there were a total of 64.2 million gym members in the U.S. and more than 10 million in the U.K. at the end of 2019. Peloton has barely scratched the surface in terms of U.S. penetration. Furthermore, the company only recently expanded its product offering to the U.K. in 2018.
Adding to the growth potential of the fitness industry (and PTON’s potential), the pandemic has caused individuals to start caring more about their health.
PTON Stock Concerns? Very Few
By now, it’s probably clear that I’m very optimistic about Peloton stock. But investors need to consider a few risks as well. As things re-open over the next 6 to 12 months, I expect people to exercise at home less. For example, they’ll go out and travel more. However, once the re-open hysteria settles, I believe people will use their bike as much as they did during the pandemic. Ultimately, it will likely become a key part of daily/weekly routines post-Covid-19.
The company also has a supply chain issue, where it has struggled to meet the incredible demand for its products. In the latest quarter, Peloton reported $576.3 million in customer deposits. These are payments received in advanced before goods are transferred to the customer. In my opinion, there could be much worse problems for a company to have.
Final Thoughts
Some might find Peloton’s current valuation expensive. They might also believe that the home fitness trend will fade with the pandemic. However, I believe that rise in connected home fitness will continue. I also beleive that Peloton is set to grow at robust rates in the years to come.
PTON stock might not trade at these price levels for much longer — I am seriously considering starting a position.
As of this writing, Thomas Logue, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.
