Peloton: Subscription Churn Continues (NASDAQ:PTON)

When I look at a company like Peloton (NASDAQ:PTON), I often marvel at how quickly a beloved, popular company can turn into a pariah when it’s subject to the whims of consumer demand. The exercise-bike maker was one of the hottest stocks to trade during the pandemic, but amid this year’s recession and continued normalization of post-COVID life, the company has continued to stumble.

Year to date, shares of Peloton have lost ~25%, but continue to be well over 90% below all-time pandemic highs. The stock has staged a minor recovery over the past month on little positive news (mostly in sympathy with the rebound in other growth names), but in my view, this is a dead-cat bounce that can’t be trusted.

I last wrote a bearish note on Peloton in September, when the stock was trading in the mid-$4s. Since then, the stock has rallied (again, mostly in concert with other small/mid-cap growth names as interest rate expectations have decreased), despite what I view to be a poor fiscal Q1 earnings report that the company released in early November. I remain bearish on Peloton and believe the stock has further downside in 2024.

It’s worth noting, in the snapshot above, that Peloton’s own outlook for FY24 (which is the year ending in September 2024 for the company) calls for a -2% y/y revenue decline. The only saving grace here is that it is expecting a much more benign loss from an adjusted EBITDA standpoint, driven primarily by a substantial expected increase in gross margins as the company raises hardware prices to not take losses and mixes more into subscription revenue as product sales continue to dwindle. But cost-cutting and smaller losses is barely a concession that the company can offer, when the business has exhibited such negative trends over the past two years.

As a reminder, here are what I view to be the key red flags for Peloton:

• Product recalls and a stained brand image- Peloton has suffered a number of very visible product recalls that, in my view, have diminished its premium image. Competitors like NordicTrack may be less flashy, but they’re certainly much cheaper and don’t come with recent headline baggage.
• Partners are pulling back- Peloton relies on channel partners to boost its point-of-sale presence and exposure to customers. In the current leaner macro times, resellers are hyper-sensitive to reducing inventory levels to free up cash, which is hurting Peloton’s hardware sales.
• Can we really justify that Peloton is cheaper than a gym membership? Let’s ignore the economics of an expensive bike or treadmill purchase for a moment and consider Peloton’s $89/month package which includes a standard Bike (not Bike+) rental and a subscription to Peloton App+ (a $24/month value, and not the full All-Access subscription at $44/month). Needless to say, there are many gyms in the <$100 category, so Peloton’s only appeal here is convenience.
• Unclear replacement cycles- And in a world where Peloton’s core customer base is not end-consumers but gyms, it’s unclear how long Peloton bikes last and if gyms will routinely replace equipment – limiting Peloton’s potential to keep preserving its revenue base.

The company is working on several growth drivers for FY24, of course – the chief two being rentals and a greater focus on the paid Peloton App experience. Rentals are now approximately one-third of the company’s Bike orders – but still, it’s not a large business, with the company expecting to end FY24 with 75k renters, up from 54k at the end of the most recent Q1. At $89/month for the most basic Peloton Bike model, 75k renters translates to just ~$80 million in annual revenue, which is a small fraction of the company’s ~$2.8 billion expectation for the year.

All in all, I continue to see few catalysts that can rescue Peloton from weak sales, continued losses, and an already-strained balance sheet. Maintain caution here and remain on the sidelines.

Q1 download

Let’s now go through Peloton’s latest Q1 (September quarter) results in greater detail. The Q1 earnings summary is shown below:

Revenue declined 3% y/y to $595.5 million, roughly in-line with Street expectations of $600.3 million (-2% y/y). Hardware/products revenue declined 12% y/y to $180.6 million, while subscription revenue was flat at 1% y/y to $415.0 million – now representing more than two-thirds of the company’s revenue. Of course, that mix does tend to tilt in fiscal Q2, as the holiday season weighs more heavily toward hardware sales.

Note that’s not necessarily positive from a profitability standpoint. Peloton’s hardware products barely make any money (and in fact, they used to lose money). As seen in the chart above, products gross margin was only 3.1%, though that’s 30 points better than a 27% loss in the year-ago Q1. Total gross margins shifted up by 1270bps to 47.9% in the quarter, driven by the boost in hardware profitability plus the much heavier subscription revenue mix in the quarter – which I view to be the major positive for the quarter.

Still, trends in the subscription business are concerning. Churn continued to be high, with paid fitness subscriptions continuing to decline by 33k paid subscribers to 2.964 million, after losing 30k subscribers in the previous Q4. Meanwhile, subscribers for the Peloton App – which the company just launched on a standalone basis in May of this year – dwindled sharply, losing 65k paid members in the quarter to 763k. In the company’s shareholder letter, CEO Barry McCarthy wrote that in the App business, “we were less successful at engaging and retaining free users and converting them to paying memberships than we expected.”

The company’s strategy for fixing this, as noted in the shareholder letter, is:

We did two things in response. First, we shifted our marketing spend to focus on our paid App. That shift worked well and is driving a higher mix of premium priced App+ subscribers than we were expecting. Second, we redoubled our efforts to remove onboarding friction in our App to support new users in finding their first Peloton classes. This will be a long term work in process.”

The company’s Q2 outlook calls for total paid Connected Fitness subscribers to rise back to a 2.97-2.98 million range, but for paid app subscriptions to fall to 660-680k subscribers. Higher than expected churn is expected as many subscribers who joined the Peloton App before it changed its pricing tiers in May 2023 are going to lose access to legacy content within the quarter. Overall, there’s not much hope for growth in the subscription business – despite this revenue stream now being the backbone of Peloton’s entire business as well as its profitability.

The good news is that less sharp losses on hardware have helped Peloton’s adjusted EBITDA swing to a slight positive, and for free cash flow burn in the quarter to reduce -67% y/y to a loss of $83 million in the quarter. Still, we continually worry about Peloton’s liquidity.

As shown above, at the end of Q1 Peloton had only $748.5 million of cash remaining on its balance sheet – and that’s more than offset by $1.69 billion of debt.

Key takeaways

Peloton has arrested its growth declines and is hoping to return to slight growth in the second half of FY24, but can it do this when A) hardware sales are weak, owing in large part to a retraction in consumer spending and B) subscription retention has trended so poorly over the past year? And with limited liquidity on its balance sheet and a mounting load of debt, Peloton has limited time to address these issues before it gets crunched.

In my view, this is not the right stock to bank on.