Peloton: Down 80% In 6 Months, But Don't Buy This Dip, Avoid

Summary

• Peloton's stock is down 80% in 6 months. As I've been arguing consistently, avoid this name.
• Peloton doesn't just burn calories. It also burns through cash. A lot of cash. In fact, it burns 79 cents of free cash flow for every $1 of revenue.
• Peloton is a stock that I've declared to be overvalued and with potential shareholder dilution on the cards. Yesterday, JPMorgan and Goldman Sachs sourced Peloton with much-needed cash.
• By my estimates, Peloton will need to dilute shareholders within 3 quarters.
• As always, happy to discuss my thesis further in the comments section.
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Investment Thesis

Peloton Interactive, Inc. (NASDAQ:PTON) reports Q3 2022 results that show that it's burning through a meaningful amount of free cash flow.

For Q3 2022, for every $1 of revenue, Peloton burns through 79 cents of free cash flow.

At this point in time, it's important to remember David Einhorn's quote:

What do you call a stock that's down 90%? A stock that was down 80% and then got cut in half.

I hereby maintain my sell rating on this stock.

Revenue Growth Rates Turn South

Peloton revenue growth rates

Talk about Covid losers. Peloton's revenue growth rates are now meaningfully negative. The guidance for Q4 points to negative 25% y/y revenue growth rates. It's difficult to imagine now that just a few quarters ago Peloton had triple-digit revenue growth rates.

Peloton's revenue consensus estimates

As you can see above, analysts were expecting that for Q4 2022 Peloton's revenue growth rates would be down 12%.

However, Peloton's own guidance for Q4 now points to a negative 25% y/y decrease in revenue growth rates. This is a 1,300 basis point deceleration from analysts' estimates.

Peloton's Near-Term Prospects

Peloton was once viewed as a growth stock. Now, it's playing for survival. Peloton's new CEO Barry McCarthy, calls this turnaround ''stimulating and engaging."

When it comes to investing, it's important to know exactly what type of company an investor is deploying capital in. A growth stock has certain characteristics, while a value trap has others. I believe that Peloton is the latter.

For their part, Peloton highlights that its subscriber churn rate is less than 1%. A clear indication that the members on the platform are engaged and content on the platform.

Peloton Q3 2022 shareholder letter

That being said, the guidance for Q4 points to subscriber growth numbers being up just 1% sequentially from Q3 2022. Again, everything depends on the perception that investors have of the company. Is it a growth stock or a cigar butt?

Path to Profitability Discussed

Let's analyze Peloton's profitability over time. In Q3 of last year, Peloton's EBITDA margins were 5%, while Q3 of this year EBITDA margins turned to a negative 20%.

Similarly, for Q4 2021, its EBITDA margin was negative 5%, while the guidance for Q4 of this year drops to negative 16%.

Consequently, there's no doubt that Peloton's path to profitability is struggling to move in the right direction.

Similarly, consider this, during Q3 2022, Peloton's free cash flow was negative $746 million. Given that the business only grew revenues to $946 million during Q3, it feels like that for every $1 dollar of revenues, Peloton has to burn through 79 cents of free cash flow.

With this free cash flow burn in mind, in the next section, I'm going to explain why I believe that Peloton is still overvalued.

PTON Stock Valuation -- Still Overvalued

Approximately 3 weeks ago I wrote a sell recommendation on Peloton.

Author's coverage of Peloton

My thesis was that Peloton is burning through a massive amount of free cash flow and that it would have to resource to diluting shareholders to raise much-needed capital.

Somehow, it appears that JPMorgan and Goldman Sachs were willing to finance Peloton with $750 million worth of capital. At the time of writing, I don't know the terms. But it's difficult to envision anything but highly onerous terms. I suspect at least an 8% interest rate on this debt.

Therefore, this debt raise, together with the cash on its balance sheet of $879 million in cash and equivalents at the end of Q3, means that Peloton now has approximately $1.6 billion of cash on hand.

However, since the business is likely to burn through approximately $500 million of free cash flow in Q4 2022, this implies that by estimates, Peloton has only got enough cash on its balance sheet to withstand 3 more quarters at the present burn rate, before having to do an equity raise.

The Bottom Line

Peloton notes in its shareholder letter that the business is ''thinly capitalized for a business of our scale." Essentially, Peloton is informing shareholders that they have little choice but to raise equity.

This may have once been a darling stock. But the tide has now turned. And there's little reason to argue that the floor is now evident on the stock. Whatever you decide, good luck, and happy investing.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.