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Investment Thesis
Peloton (NASDAQ:PTON) is about to report its fiscal Q2 2024 results this Thursday, premarket. Peloton will have a lot to prove to investors in its upcoming H2 2024 guidance.
More specifically, the one thing that’s holding up the stock right now is Peloton’s declaration that it will be “[substantially] positive free cash flow in the second half of this fiscal year”.
If Peloton’s confidence in its outlook wanes, all of a sudden, investors’ focus will swiftly move from its free cash flow outlook to its overly leveraged balance sheet.
Altogether, I do not believe this stock offers investors a compelling risk-reward. As I believe the real money in the market isn’t made by playing the hero and betting on highly charged and volatile stocks. But investing in high-quality businesses that are becoming increasingly profitable, even though their increasing profitability is not getting recognized by investors.
Rapid Recap
Back in November, as it headed into fiscal Q1 2024 earnings results, I wrote a bearish analysis on Peloton where I said,
Even if Peloton somehow finds some bunnies at the bottom of its bag with which to delight its investors positively, I make the case that this stock is unlikely to deliver investors positive returns over the next twelve months. Indeed, I contend that investors will, in twelve months, look back to Peloton’s $5 share price as an aspirational price to head towards, not as the low price to enter this stock. In sum, Peloton is overvalued, and its balance sheet is on a perilous footing. I recommend that investors avoid this stock.
Author’s work on PTON
As you can see above, the stock has outperformed the S&P500 (SPY) by more than 500 basis points in 3 months. That being said, I believe that despite the stock moving higher, this stock still has unresolved issues, as you’ll soon read. Accordingly, I maintain my bearish view of this stock.
Why Peloton? Why Now?
Peloton faces several challenges. One of the significant challenges is the reintroduction of the Tread+ this quarter. While the company aims to take pre-orders and generate incremental cash flow and revenue, the success of its reintroduction of the Tread+ is uncertain. Recall, that Tread+ has faced safety concerns in the past, leading to a temporary halt in sales.
Another challenge is the need for continued success in growing app-related subscribers. The company emphasizes the importance of app engagement and subscriber growth, indicating that achieving these targets is crucial for Peloton’s overall business strategy.
Additionally, the core all-access membership growth is highlighted as a key factor. Any difficulties or slower-than-expected growth in the core all-access membership could pose a challenge to Peloton’s overall revenue and profitability targets.
In terms of the competitive landscape, the partnership with Lululemon is a noteworthy development that investors should be eager to hear of its progress. As you know, the competitive landscape in the fitness industry is dynamic, meaning that the occasional partnership is unlikely to be sufficient. Peloton needs to be able to stand on its own two feet.
Given this context, let’s now discuss its upcoming guidance.
Revenue Growth Rates Should Stabilize, But Will That Be Enough?
PTON revenue growth rates
Peloton is about to deliver approximately negative 5% y/y revenue growth rates for its fiscal Q2 2024 results.
What’s more, management will be keen to argue that the outlook for the remainder of fiscal 2024 implies that the worst of Peloton’s right-sizing has already taken place.
Peloton will be eager to declare that it is in the process of turning around its prospects. They’ll put forth a very compelling narrative. But I recommend investors don’t fall into the trap of believing that just because a stock is down from its heights, means the stock is undervalued.
In the absolute best case scenario, Peloton will guide towards mid-single digit growth rates as a forward run-rate for the remainder of fiscal 2024. This is not a growth stock, that has temporarily fallen out of favor and primed for a comeback.
PTON Stock Valuation — Overvalued
Before we go further, keep in mind the following.
The current effective interest rate on the Term Loan is 14.3% as of September 30, 2023.
That’s a line from Peloton’s fiscal Q1 2024 SEC filing. More specifically, this means that on its debt alone, Peloton is paying out slightly more than $90 million per year on interest.
On top of that, there’s also $1 billion of convertible notes due in 2026, which equates to 50% of its market cap. This means that this business is layered with debt and with poor growth prospects.
Even if Peloton guides for its free cash flow in fiscal H2 2024 to be substantially profitable, I struggle to see how this business will succeed in going from approximately negative $320 million in free cash flow in fiscal H1 2024 to anything more than positive $100 million of free cash flow in fiscal H2 2024, notwithstanding management’s proclamation that Peloton will achieve near breakeven free cash flow in fiscal 2024, see below an excerpt from its shareholder letter.
[…] substantial positive free cash flow in the second half of this fiscal year, with a goal of achieving near breakeven free cash flow on a full year basis.
When all is considered, I make the assertion that this stock does not offer investors a positive risk-reward and it’s best avoided.
The Bottom Line
In conclusion, my outlook on Peloton remains bearish as the company approaches its fiscal Q2 2024 earnings release.
The upcoming guidance will be crucial, and while management may present a compelling narrative of a turnaround, the debt-laden balance sheet and poor growth prospects suggest caution.
Despite the stock recently getting bid up, I maintain a bearish view on Peloton, emphasizing unresolved issues and recommending investors avoid the stock.
Peloton Fiscal Q2 2024 Earnings Preview: Fitness Soap Opera Continues
