SUN VALLEY, IDAHO - JULY 06: Barry McCarthy, president and CEO of Peloton Interactive, walks to a ... [+]
Just because a stock’s price has dropped, it doesn’t make it cheap. For that, you need a compelling case that the stock will go up.
This comes to mind in considering Peloton — the maker of Internet-connected stationary bicycles and treadmills — whose stock has lost 95% of its value since peaking in December 2021 at about $171 a share.
While it may lower its costs by outsourcing all manufacturing, according to the Wall Street Journal, I see three reasons to avoid its shares:
- Declining revenue and poor prospects
- Weak cash position
- Shaky management team
(I have no financial interest in the securities mentioned in this post).
Declining Revenue And Poor Prospects
Peloton reported a plunge in revenue and a record loss in the first quarter of 2022.
Peloton’s March 2022-ending quarterly revenue fell 24% and it reported a loss of $757 million, according to the Wall Street Journal. Peloton blamed lower customer demand and “the cost of carrying a $1.4 billion inventory of unsold bikes and treadmills.”
In January, Peloton forecast 2022 revenue in a range — $4.4 billion to $4.8 billion — the midpoint of which is 14% higher than its fiscal 2021 total and $790 million below analysts’ consensus, according to CNBC.
By May, Peloton — which in February replaced its founder Jack Foley as CEO with former Netflix CFO
To be fair, McCarthy thinks Peloton can prosper by outsourcing manufacturing of hardware and becoming a service company like Netflix. According to the Journal, he said in May that Peloton will test a new pricing system in which customers’ monthly fee covers the cost of the stationary bike and its workout courses.
I am skeptical that this model will work for Peloton because it depends on rapid subscription growth to support rising revenues and a soaring stock. I warned in April that this might not continue for Netflix.
Netflix then lived up to my expectations. Its stock collapsed shortly thereafter following a drop in first quarter 2022 subscriptions and a gloomy forecast for the year.
The same thing could happen to Peloton. As Seeking Alpha wrote, “With Peloton's US subscription fee scheduled to increase from $39 to $44 in July, higher subscription prices could potentially lead to higher churn rates as consumers increasingly turn their attention to outdoor activities and traveling.”
Weak Cash Position
At the beginning of January, I offered three reasons why I thought Peloton stock — which then traded at $35 a share — would keep falling. Since then it has fallen 74%.
One of those reasons was a weak cash position. At the end of September 2021, it posted negative $473 million in free cash flow and its balance sheet cash fell nearly 43% — leaving the company with $613 million in cash.
Its most recent financial position is not quite as perilous. By the end of March, Peloton’s cash balance had risen to $879 million after burning through $711 million in free cash flow, according to the Journal.
In May, Peloton announced that it had borrowed $750 million from JP Morgan and Goldman Sachs — payable over five years, reported the Journal. In May, the interest rate on the floating rate debt was above 8%, according to Bloomberg.
However, since then the Fed has raised interest rates and is likely to hike rates another 75 basis points as inflation remains high — hitting 9.1% in June, noted the Journal.
Peloton urgently needs to reverse its cash burn rate. Its July 12 announcement that Taiwanese manufacturer Rexon Industrial will become its primary bike and treadmill manufacturer and its suspension of operations at its Tonic Fitness Technology plant will reduce its cash burn rate, McCarthy told the Journal.
Will that reduced cash burn rate be enough to keep Peloton from running through its cash?
Shaky Management Team
With founder Jack Foley — who with his family owns 60% of its voting shares, according to Bloomberg — serving as Peloton’s executive chair, I can’t help but wonder whether McCarthy was brought into the company to stabilize its financial position and then depart.
He clearly has much work to do for the company to generate positive free cash flow. Were that to happen, Peloton might be an attractive acquisition candidate. That could be difficult to achieve because I am skeptical that subscription service-based business model will enable it to resume the spectacular growth it enjoyed during the height of the pandemic.
I think those who bet that Peloton’s stock will keep falling — 12.15% of its float is sold short — have the best chance to profit here.
