Summary

• Peloton has doubled revenues for the last three years. The company boasts 3.1 million users and a retention rate of 92%.

• The stock has had a huge run-up thanks to the pandemic and now trades at 12 times sales and an enterprise value of $27 billion.

• The valuation is not cheap but there is still room for upside. I am taking a half position and will add more on a significant pullback.

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Provider of high-tech exercise bikes and online fitness classes, Peloton (PTON) recently delivered its first quarterly profit alongside revenue that was up 172% year over year. Since then, the stock has continued to move to new highs even as the broader market has dipped.

Prospects

Prospects for Peloton over the next five to ten years look good. The company is benefitting from two major trends; wellness and the global pandemic. 

Lockdowns and social distancing have left people unable to go to the gym so they are staying indoors and using virtual fitness classes and home equipment instead. This trend will likely continue as cases of the virus pick up through autumn and winter.

The pandemic will eventually subside but fitness and wellness trends will continue for some time. Peloton has the opportunity to strengthen its brand in the home fitness market and penetrate other outlets like hotels and gyms.

Margins

Peloton bikes are sleek and expensive and subscriptions to online classes provide recurring revenue. This means Peloton can generate surprisingly high gross margins of 46%. Incidentally, margins have risen from 34% in 2017.

Hardware margins are higher than Apple and subscription prices add stickiness and stability. The company doesn’t exactly print money but it’s business model seems to be working well.

Financials

Price to earnings is unreliable here since Peloton is in growth mode and re-investing capital for future growth. Cash is going into projects like new bikes, treadmills, geographic expansion as well as marketing.

Revenue growth, on the other hand, has been robust growing at an impressive 100% for the last three years. An enterprise value of approximately $27 billion with trailing revenue of $1.8bn means the stock is currently trading at around 12 times revenue which is pricey but not stratospheric considering such growth.

Researchers at S&P Capital IQ think revenue growth could continue at Peloton at 47% through 2021. If we apply a similar multiple of 12 times to that projection we get a market value of $32 billion, implying an upside of around 18% from the current level.

However, this projection was made before the full effects of the pandemic and they now look timid considering Peloton latest quarterly revenue was up a whopping 172% and yearly revenue up 100% to $1.8bn.

With virus cases ticking up and winter approaching there’s reason to believe that strong growth will continue at Peloton for at least the next two quarters. If revenue was to double again in 2021 then a 12x multiple would imply an upside of 60% from the current level. Optimistic, but perhaps obtainable longer term.

On the balance sheet, total debt is manageable at $545 million, which is about three times below annual revenue and three times below net cash. 

Technicals

Peloton is currently trading at a new all-time high and the monthly chart is significantly overbought with a YTD return over 250%.

This is negative for the short-term but my own historical analysis points to it being a neutral factor over the long term. In addition, short interest is relatively low at 4.41% and turnover is high indicating robust investor demand.

10X Potential

With an enterprise value of $27 billion the chance of getting a 10X return from this level is diminished. A 10X return would put it at a similar valuation to companies like Netflix and Adobe today. A lot of things would need to go in Peloton’s favour for that to happen. I think a more likely result would be a double or triple over the next two to three years. 

Competitive Advantage

I believe qualitative factors like brand, feedback loops, and patents to be some of the most valuable features of a business and I like to see a company possess at least one of these key features before making an investment.

While Peloton is not yet a household name, there are some signs that it is acquiring a strong brand with its emphasis on sleek design and aspirational qualities. However, the brand is not there yet.

The most significant competitive advantage is the company’s network effects. After buying a bike and subscription, customers compete with others (including their friends) to move up the leaderboard.

This drives a true network effect where the more people that sign up the more valuable the service becomes. Just like Facebook did in its early days, the network effect can result in an exponential like increase in members. This partly explains the strong user retention rate of 92% as well. 

Risks

With all that said, there are still significant risks to be aware of. The company has only reported one profitable quarter and earnings are unlikely to grow substantially while the company invests for future growth. 

Competition comes in the form of SoulCycle, Mirror and NordicTrack. Apple also recently announced it’s entrance to the fitness subscription market with Fitness+.

Peloton, however, does enjoy first mover advantage, a growing community and aspirational qualities that means it is pulling ahead.

A lot of criticism levelled at Peloton is the high price of the equipment with the bike coming in at $2245 and treadmill at $4295. 

The big question is whether or not consumers will continue to pony up for a Peloton bike when they could alternatively buy a cheaper bike and simply watch the $12.99 classes on a smartphone or tablet. 

The FT reports that connected bike subscriptions ($39 per month) increased by 113% in the last quarter but the cheaper $12.99 classes (available to all) increased by 210%. This supports the theory that users could buy the classes but not the bikes.

The sheer size of the equipment and accompanying screen could also make it a no-go for some smaller inner city households. 

That said, Peloton will no doubt bring a cheaper bike to market which will help to fill this void and mean upsell opportunities for existing subscribers.

There is also continued opportunity in the form of hotels and gyms who might be interested in Peloton equipment as well. 

Final Verdict

In some ways, I find it hard to see Peloton equipment becoming ubiquitous in people’s homes due to their sheer size and high price. However, you cannot argue against the data which points to tremendous growth, good margins and strong retention of users.

Peloton has already had a great run with the stock up 250% year-to-date. However, management appears to be executing well and creating a strong brand. 

The opportunity for a 10x return has probably gone in Peloton but I can see this stock hitting a $50 or $60 billion market cap in the next two to three years which would still represent a good return.

I wish I had got in earlier with Peloton but I am still happy to initiate a half position today as I think there is more upside ahead. If the stock drops back below $20bn I would likely add some more.

Disclosure: Long Peloton.

This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst. The reader agrees to assume all risk resulting from the application of any of the information provided.

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