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Stockwatch: are Peloton shares a buy after 50% crash?

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Our stock picker assesses the outlook for the troubled business both for alert traders and genuine investors. 

Is this week’s 15% sell-off in the US shares of exercise equipment maker Peloton Interactive (NASDAQ:PTON), in response to a recall of its treadmills, overdone? Or is this just an inevitable reality check for a grossly overvalued stock – pumped up by home exercising during Covid-19, and the Federal Reserve’s monetary expansion? 

The chart context is a wider fall of around 50% to $83.8 currently, from last January’s high of $171. Yet Peloton stock only took off with the pandemic. Prior to end-March 2020 it had traded sideways in a circa $20 to $30 range after floating in September 2019 at $29, which capitalised the business at around $8 billion (£6.5 billion).

Mixed third-quarter results

Late yesterday, Peloton declared sales growth of 141%, ahead of consensus by 13% and maintaining a trend of beats over the last four quarters. Latest progress significantly follows from investments in the supply chain to improve deliveries. Peloton has become a victim of demand success for its equipment during the pandemic, incurring bottlenecks. 

Though the stock continued to fall modestly in response, it regained some poise to close 1% up at $83.8. That was after the earnings call quantified the treadmill recall and delayed launch of a budget version at a $165 million reduction in expected fourth quarter sales, which it now expects to hit $915 million. This compares with $1.1 billion previously expected. There will also be a $16 million hit to operating profit because full refunds of club-style Peloton subscription fees are to be made. 

Despite this mixed outcome, the stock is most likely firming because Peloton is at least providing detail; the market hates uncertainty and any information vacuum.  

In the short term, the crux is whether a resilient narrative on cycling machines – said to constitute the vast majority of product sales – is sufficient to turn sentiment that has lately fretted about Peloton’s swollen valuation.  

Unfortunately, Peloton’s accounts do not break down its product sales, although a radio news item quoted one analyst’s claim that treadmills constitute only 2% of group revenues and 5% of subscriber revenues. 

Can Peloton put this treadmill fiasco behind it? 

After a series of accidents culminating in the death of a child, the general public first became aware of Peloton this week by way of news headlines about recalls on treadmills that cost between $2,500 and $4,300. It has jolted investor confidence justifiably, given the CEO had dismissed regulatory concerns and claimed that promising UK sales of a cheaper treadmill were bullish for launching it in the US. He says the treadmill marketing opportunity is larger than for exercise bikes.   

Despite the product high prices, Peleton’s gross margin has been none too exciting at around 45%, and the summary table of income statements (see below) shows the company yet to genuinely tip into earnings – able to justify a price/earnings (PE) ratio of well over 100x what some analysts entertain, on a forward view. 

Short sellers – around 7% of the issued share capital is loaned out – see Peloton as a prime example of a fashion stock boosted by transitory “working from home” during the pandemic, and also the Federal Reserve aiding a stock trading mania.  

Peloton Interactive, Inc
Summary income statements
$ millions

Year to 29 June   2017 2018 2019 2020
Total revenue   219 435 915 1,826
Cost of revenue   145 245 531 989
Gross profit   74 190 384 837
Operating expenses R&D 13 23 55 89
  general 132 214 531 829
  Total 145 237 586 918
Operating income   -71 -48 -202 -81
Interest expense   0 0.3 0 0
Other income/costs   0 0 -0.3 -4
Pre-tax profit   -71 -48 -196 -68
Taxation   0 0.1 0.1 -3
Net income   -72 -48 -196 -72

NordicTrack looks a tough and better diversified rival  

It is possible that fitness buffs put aside treadmill issues. “Must have the best equipment, to attain the best body” may characterise their perfectionist mentality. 

Yet rival NordickTrack must be rubbing its hands. Versus nine-year-old Peloton, it has a US history going back to 1975 and was acquired by Icon Health and Fitness in 1998. It is more diversified, selling elliptical trainers, rowers and strength training machines.  

Perusing these rivals’ bikes and treadmills, they are quite similarly advanced. Both offer high-definition touchscreens, although Peloton’s bikes link to smart watches while NordicTrack offers real-world routes e.g. via Google Maps. Peloton’s treadmill offers a slightly faster top speed, but NordickTrack’s incline goes up to 40% versus 15% for Peloton and also uniquely offers 6% decline. 

Peloton therefore does not enjoy exclusivity at the high end of fitness equipment, in support of a lofty valuation. Say revenues of $1.8 billion for the year to June 2020 advance in due course to $4 billion annualised, the stock currently trades over 6x such sales. 

Has the ‘working from home’ driver peaked? 

With such machines costing four-figure dollars or pounds, they are typically a preserve of affluent professionals kept out of offices and urban gyms since Covid-19 struck. The last 13 months’ ramp-up in sales seem quite like other home improvement measures people have taken. Are such machines attuned to the market going forward? I concede a bias, having had an exercise bike years ago that ended up in a skip, replaced with two wheels. 

More positively, perhaps an element of the population will not want to return to busy gyms and indeed prefer exercising at home than braving adverse weather and traffic. 

My suspicion is that high-end professionals able to buy such equipment are in the forefront of their own “recall”. Goldman Sachs for example has asked its US and UK employees to return to the office by 14 July. Its CEO says remote working is an “aberration” not conducive to productivity. “It is not a new normal…collaboration, innovation and apprenticeship thrive when people come together.” 

Fundamentally, Peloton equity is a play on an advancing global market for the kind of bulky expensive exercise machines you would normally find in a gym. I can envisage international sales advancing, but am unsure quite whether recent US/UK sales will be sustained at similar rates as lately.  

Maybe Peloton adapts and diversifies from reliance on such equipment but, for now, and given the treadmill problems, it seems quite a “one product company” selling expensive indoor bikes.

Classic ‘head and shoulders’ chart currently 

The chart is drawn out from last October, but after a “head” from late December to early February, the shoulder is now in place. I suspect there will be an element of traders watching the near-term chart for enough momentum to back a rebound of sorts. 

Value-driven investors are in a dilemma. It is impossible to say what this stock is worth until its income statements mature to show sustainable earnings.  

Bank of America recently had a ‘buy’ stance targeting $150 a share – now slashed to $100 after the treadmill recall news. When attractive round targets get touted as valuation targets – especially in a mature bull market – I tend to see this as symptomatic of the times. Valuation is never as clear cut: if attempting to value Peloton you would anyway have to consider a range of scenarios, resulting in odd numbers. But if you are promoting stock, it helps to keep them nice and round at a premium to current price. 

It may be possible to scalp gains if buyers materialise shortly, but for medium-term investors I regard Peloton as essentially a pandemic trade. Avoid

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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