As Peloton Shares Fall Over 90%, A Comeback Strategy Surges

Key Points

• Shares of Peloton have declined by 95% from their all-time high prices in 2021. After a difficult path, management has been cornered to find a way to relaunch the company's approach to profitability. 
• Today, executives are focusing on moving away from Peloton being a product-based company into a more service-based company, which has already shown positive signs in the company's margins. 
• Significant progress in pivoting revenue mixes has brought Peloton close to positive free cash flow, a milestone that could likely stop share dilutions and even bump analyst ratings, which today see a 62% upside scenario.

Shares of Peloton Interactive NASDAQ: PTON reached their all-time high prices of $170.09 per share in January 2021; after a whole two years of facing challenging economic environments and a stern test to their value proposition, the stock is selling for below $10 to mark a 95% retracement in the company.

As the company reached one of its lowest valuations, both in valuation multiples and in the stock price since its IPO, management has come together to strategize a new path out of the slump. This latest comeback strategy may be the catalyst investors need to see the company back at its former glory.

As the United States reports a 4.0% rate of core inflation for the month, representing an improvement from the 4.1% consensus and a reduction from the previous tape reading of 4.9%, more stock traders are betting on the FED pausing its interest rate hike campaign.

As names like Bank of America NYSE: BAC begin to gain momentum in an upward movement, markets gain more confidence that the economy may be bottoming, as financials are typically the first basket of stocks to move ahead of the economy's pivot. Considering these events, the American consumer may allocate new buying power to a Peloton subscription.

Peloton, A New Plan

Peloton became known as another fitness brand, selling suitable - and pricey - workout bicycles to enable a better 'at home' workout experience. Today, after a punishing stock price decline, CEO Barry McCarthy is looking to see the Peloton brand's rebirth as a more comprehensive service company. While the company will still derive most of its revenues and sales activity from the 'Connected Fitness Products' segment, which includes its apparel accessories, bicycles of various tiers, and now a rowing machine, management is looking to increase the share of subscription revenue that represents the top line.

Other companies who felt a fraction of Peloton's pain include Lululemon Athletica NASDAQ: LULU, who began to move away from its 'Mirror' product to focus on a more subscription-based revenue model. A subscription enabling users to access Peloton's various instructors and workout types, at whatever price is still to be released, is a more straightforward path to delivering value than a $3,000 rower. When the company reported its first set of financials in 2018, only generating $435 million in revenue, subscription-based revenue only made up 18.4% of the net.

Peloton's financials will show the year 2022 closing with $3.5 billion in revenue, of which 38.9% came from subscriptions. As of the third quarter press release, Peloton generated $748.9 million in revenue, increasing its share of subscription-based income to 56.7% of the whole. Likewise, gross margins grew from 19.1% during the third quarter of 2022 to a significantly higher rate of 36.1% a year later. As the company focuses its efforts on subscription revenue, which is inherently a higher margin venture, the Peloton brand has a new path to scale and be recognized by more potential users with a fraction of the effort and cost.

Don't Miss the Bus on Peloton

As the revenue composition experiences its pivot away from a product-based company into a more service-based entity, growth rates may stall a little. However, value investors may be all right with giving up some percentage points of revenue growth when considering what happens next. As subscription-based revenue takes a larger share of net sales, the quality of the underlying increases significantly due to their nature being a more consistent and recurring one. As Peloton's revenue streams become more stable and of higher rate, the stock may command a higher multiple of sales valuation.

Peloton's price-to-sales ratio reached a low, along with its stock price, around July 2022. Bouncing back from its bottom 1.0x multiple, today's 1.7x is still well below its historical 4.0x to 8.0x range. One catalyst that may bring these valuation multiples back to historical ranges is the revenue composition pivot, alongside markets realizing the growing momentum in the higher margins these activities will get for the overall business. The second part of the story comes from these same margins expanding. Peloton posted a 93% annual increase in its free cash flow levels. 

These margin improvements feeding to Peloton's free cash flow generation power will be a significant milestone in sentiment pivots for the company. Despite a negative free cash flow level of $55.3 million, it is a massive improvement from a negative $746.7 million a year prior. Reaching positive free cash flow can prevent the company from issuing common stock to fund operations. Peloton's analyst ratings may reflect these same tailwinds, as they have assigned a 62% upside from today's prices.