Should You Buy the Peloton (NASDAQ: PTON) Rally?

When the Pfizer NYSE: PFE vaccine news was released, the market spent the next trading session (November 9) sorting out the winners and the losers. Peloton NASDAQ: PTON shareholders were fearful about the company’s ability to thrive in a post-vaccine world, and rushed to the exits; by the end of the session, one-fifth of Peloton’s market cap had evaporated.

But Peloton shares have made a comeback, and are now approaching where they were just prior to when the vaccine news came out.

Peloton has been one of the most prominent pandemic winners in the market. With gyms shuddered and physical fitness a key component of fighting the effects of COVID-19, home workouts have become increasingly popular.

But I’m here to tell you that a post-vaccine world will not be kind to Peloton.

 Peloton shareholders and management are both making a lot of dangerous assumptions about the company’s future. Assumptions that will come back to haunt shareholders over the next year or two.

A Great Business Model, But Unrealistic Expectations

Peloton has around 1.8 million active subscribers. Subscription revenue currently makes up around 20% of Peloton’s revenue.

I’ll start by admitting that it’s a great business model. Subscriptions are sticky, so most of those 1.8 million are likely to stay with Peloton for the long-term. Particularly considering that customers dropped $1,895 to $4,295 for the bikes. The $39 a month subscription looks like pocket change in comparison.

Furthermore, Peloton’s video content costs are fixed. Which means as the company adds subscribers, its content costs will stay the same and its margins will expand. And this isn’t a Netflix NASDAQ: NFLX situation; Peloton doesn’t have to invest heavily in original content in its industry.

Okay, so the business model is great. Where’s the rub?

Peloton is trading at more than 380x forward earnings and 9.1x forward sales. A lot of growth is priced into shares. Management, it turns out, is creating unrealistic expectations for subscriber growth.

At the company’s investor meeting back in September, CEO John Foley had this to say: “100 million subscribers, we believe is a reasonable goal. There’s close to 200 million gym-goers in the world. That’s 200 million people paying hard money, month after month, to access what we believe to be inferior fitness equipment in an inferior location.” 

Foley also pointed out that there are 35 million US householders with a treadmill; he thinks he can turn a large percentage of them into Peloton subscribers.

Let’s start with the “reasonable goal” of 100 million subscribers, which would be more than a 50x increase over Peloton’s current subscriber base:

First of all, Foley is completely discounting in-person gyms by calling them “inferior.” That’s simply not the case. The access to a wide variety of exercise equipment and sense of community are just two of the many advantages that gyms hold over home workouts.

And even if more and more people workout at home post-pandemic, Peloton faces increasing competition. Apple NASDAQ: AAPLFitness+, for example, is now available for $10 per month. What’s stopping would-be Peloton subscribers from buying a $500 exercise bike and streaming video content from Apple?

Then, there’s the treadmill statement, which was terribly misguided:

 Yes, Peloton will turn a few of those treadmill users (or non-users) into subscribers. But I don’t see it being a meaningful percentage. Millions of Americans have an old treadmill collecting dust in their basement. Are they really going to run out and buy a Peloton for $2k? And then pay $39 a month to use it? I highly doubt it.

Supply Constraints are Coming at a Bad Time

In the Q1 2021 earnings call (the period ending September 30), Peloton said its Bike+ will face “supply constraints for the foreseeable future, causing longer order-to-delivery time frames for Bike+ for a couple more quarters.” Management acknowledges that “wait times for our products have been unacceptably long.”

Look, I’m not going to sit here and bash Peloton for this: it was impossible for Peloton to foresee this avalanche of demand.

But the company is losing valuable opportunities to add subscribers and build brand equity. With its ambitious goals, Peloton can’t afford any hiccups.

Avoid Peloton… For Now

I’ve made it clear that I think Peloton is a poor investment at current levels, but that doesn’t mean it will never be a sound investment.

My recommendation on Peloton is similar to my recommendation on Wayfair NYSE: W: keep an eye on it. If the company has a rough 2021 or 2022, growth-oriented shareholders could all abandon their positions at around the same time. If that happens, you could have a buying opportunity.