Buying Opportunity For Peloton After The Recent Pullback
- With the pullback associated with the tech selloff, Peloton looks apt for an opportunity to buy this dip.
- Peloton's growth potential and ability to continue growing subscribers and revenues at fast rates remains intact albeit with some obstacles.
- From FY23 to FY25, Peloton can find leverage within subscriber growth as well as new channel expansion to drive revenues at an estimated 28% CAGR.
- Supply chain issues and complications are the main major risk to the trade.
As the market digested soaring rates, valuations of high-flying tech stocks came under heavy pressure. Peloton (NASDAQ:PTON) shed over one-quarter of its value in just over six weeks, facing some tough forward multiples with inflection to profitability as sales growth soars. With the pullback associated with the tech selloff, Peloton looks apt for an opportunity to buy this dip, although there are some risks to be aware of moving forward.
Strong Growth Runway
Peloton kicked off February with a decent earnings report, posting a double beat while raising full year guidance, although comments on supply constraints sent shares tumbling ahead of the recent broader market selloff. However, Peloton's potential is visible and multiple contraction ahead of revenue growth realization provides a more attractive buying point.
Graphic from Peloton
Most financial and performance related metrics from Q2 showed triple digit growth YoY: revenues +128%, gross profit +115%, Connected Fitness subscribers +134%, total workouts +303%, and a shift to profitability.
For Q3, Peloton guided $1.1 billion in revenues, +110% YoY but reflecting only marginal sequential improvement, and 1.98 million CF subscribers, +123% YoY; for the fiscal year, revenue guidance was raised to $4.075 billion, +123% YoY, $300 million in EBITDA, and 2.275 million CF subscribers, +109% YoY.
Peloton's growth potential and ability to continue growing subscribers and revenues at fast rates remains intact albeit with some obstacles. For FY21, revenues could come in ~3% above guidance at $4.2 billion, with strong demand for products and international sales in the picture for 2H after the Tread debuted in the UK in late December. International sales channels also open up the door for CF subs to rise to 2.05 to 2.15 million, 5-7% above guidance. Net income could rise to $210 million, or $0.71 basic EPS, as revenues rise relative to expenses.
For FY22, revenues could rise ~40% to $5.9 billion, driven by international sales (up to $150-175 million) as well as strong subscription revenue growth (~$450 million on 3.85 million members); the Precor combination could also show some incremental gains in revenues. EPS could rise to $1.20, up ~70% YoY, with slight expansion of gross margin to 39-40% on volume growth, with higher gross profit offsetting any rollover in shipping/logistics expenses, as leverage of SG&A/R&D is expected with volume.
From FY23 to FY25, Peloton should find leverage within a consistently growing and significantly larger community, as well as new channel expansion internationally in more regions in Europe and possibly Asia. Subscription growth stemming from growth in membership numbers and outright channel expansion could see revenues grow at a 28% CAGR to $12.2 billion in an upside case scenario; earnings could grow at a 45% CAGR to ~$3.65.
In terms of market opportunities, decreasing model prices with the new Bike and Tread act as a double-edged sword - driving unit volumes higher while lowering top line ASP from product mix. Unit growth should easily offset any impact from the price decrease on top-line growth. The addition of Precor opens up ability to monetize new channels like small commercial/hospitality style gyms (three to five machines), as well as strength/ellipticals/rowers. While development of such new product lines could prove a bit costly from an R&D standpoint, utilization of Precor's capacity and pre-existing customer relationships to facilitate entry into new channels like the aforementioned two could spur growth.
Risks to Growth
While growth potential remains strong, there are a few risks to keep in mind at the moment, with the number one being supply constraints.
Peloton has warned for a couple of quarters that it has been facing and expects to continue facing supply constraints for a considerable period of time, as manufacturing capacity and fulfillment capabilities are unable to meet elevated demand levels.
A significant amount of orders are being carried over into FQ3 as Peloton fights to minimize a massive order backlog; the next two to three quarters are vital in working to eliminate these supply chain issues. Peloton has already invested $100 million for expediting air and ocean freight in an attempt to solve the long fulfillment times. Order backlog (and carryover of deliveries) combined with increased fulfillment channel spending and up to 10x higher fulfillment fees will suppress Peloton's bottom-line, thus dampening profitability over the remainder of FY21 and potentially into early FY22.
Playing catch-up to demand also can hurt revenue growth, as prolonged order-to-delivery times could convince customers to find alternatives, whether that be a non-connected equipment piece or a return to a gym.
The 'gym-on' trade also presents a risk to Peloton, as its equipment is typically an alternative solution to the gym, although a digital subscription could pair as a complement to some people. As vaccinations continue and gyms reopen, more people could embrace gyms again, thus decreasing the need for home gym products. This can be seen within the 'gym-on' pair trade - YTD through February, Peloton dropped 17%, while Planet Fitness (PLNT) rose 16%. Other competitions present in the home gym space include Nautilus (NLS), Tonal and Mirror (LULU), the latter two establishing themselves with wall-mounted equipment.
As Peloton invests heavily in fulfillment capabilities and capacity, ramping up the Shin Ji facility during the prior quarter to increase production volumes, the company runs a risk of overshooting demand levels in the future, which would impact both revenue growth as well as prior stated projections. If demand [red] starts to level off ahead of Peloton's expectations or at a quicker pace, the increased investments in supply chain, capacity and fulfillment would not pay off in the next six to ten quarters as supply [blue] runs at a lag.
Even with that main risk, strong growth potential and earnings generation does present a buying opportunity after the selloff.
Although Peloton's recent shift to profitability has left earnings multiples quite high, sales growth combined with the selloff has provided a more attractive valuation, similar to mid-November's valuation.
Peloton trades at just under 13x TTM sales, more reasonable compared to 20x TTM sales as it had going into the new calendar year; going forward, Peloton trades at 8.4x estimated sales of $4.2 billion for FY21, 6x FY22 sales, and 2.9x FY25's upside case sales; such a long-term outlook provides a strong valuation backdrop after the dip.
As has been the case with many high-growth stocks, Peloton has taken quite a beating over the last few weeks as the market digested high valuations amid a rapid rise in rates. Peloton had lost nearly one-third of its value since a peak earlier in January, and looks to provide an attractive entry point on the dip as sales growth remains positive at a high 28% estimated growth rate through FY25. PS multiples are much more reasonable at 6x FY2022 sales, and 2.9x FY25 sales, compared to double-digit multiples. However, the main risk to Peloton, supply chain complications, could have a large impact on growth rates, and has been an accompanying factor to Peloton's slide - should the company continue to face complications and extended fulfillment times, valuation could continue to slide, but if supply chain issues can be solved, shares could see a green light to trudge higher. It's still a risky trade due to the pair-off between home gyms, in and out of style, as Peloton chases the demand curve, and traditional gyms, as those have gained steam in a vaccinated environment - however, Peloton's loyal members, low churn, content moat, and international growth do point to success.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PTON over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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