Peloton Interactive, Inc.

Moat: 1.5/5

Understandability: 3/5

Balance Sheet Health: 2/5

Peloton is a leading global fitness company with a highly engaged community of Members, known for its technology-enabled fitness platform, offering interactive hardware, software, and content.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Peloton operates in the connected fitness industry, providing interactive fitness experiences to subscribers through a combination of hardware, software, and subscription content. The company’s ecosystem primarily revolves around:

Connected Fitness Products: These include the Peloton Bike, Bike+, Tread, Tread+, Guide, and Row. These products are designed to be used at home, with an emphasis on live and on-demand classes.
Subscription: This includes memberships that unlock access to Peloton’s library of fitness classes. Peloton offers a range of subscription options, including the All-Access Membership and App Memberships which focus on content without hardware.
Software: Peloton has developed its own proprietary interactive software platform that underpins all of its offerings. This software is designed to work well with its devices and create a high engagement environment for their customers.
Apparel and Accessories: Peloton offers its branded apparel and fitness accessories. These sales offer a minor contribution to its business.

Revenue Distribution

Peloton’s revenue streams are divided into two main categories:

Connected Fitness Products: This category includes hardware, like exercise bikes and treadmills and related accessories. It is a significant contributor to the company’s overall sales.
Subscription: This revenue is generated from monthly subscription fees paid by users to access Peloton’s content library and app-based subscriptions.

Competitive Landscape

The fitness industry is highly competitive, with a diverse array of players. Peloton faces competition from:

Traditional fitness companies: Companies providing at-home fitness equipment that may not be connected, offering limited digital solutions.
Connected fitness companies: Companies that offer at-home exercise equipment with subscription based services. Some examples include Tonal, Hydrow and Lululemon Studio.
Online fitness and streaming services: There are a plethora of at-home workout apps, like Nike Training Club, FitOn, and Apple Fitness+.
Boutique fitness studios and gyms: While they lost some ground because of the pandemic, traditional gyms have tried to evolve as well by incorporating new technology.
Discount fitness equipment retailers. Competition can come from companies that produce cheap gym equipment as a commodity.

What Makes Peloton Different?

Peloton differentiates itself from its competitors through a combination of:

High-Quality Hardware and Content Integration: Peloton integrates proprietary hardware with its digital fitness content to create a connected fitness ecosystem.
Engaged Community: Peloton fosters a strong sense of community through its platform, where members can interact with each other and instructors.
Live and On-Demand Classes: Peloton offers a combination of live and on-demand classes, which provides users with flexibility and a variety of content.
Brand: A large percentage of Peloton’s value lies on their brand, especially as it appeals to the high end customer base.

Financials

Revenue

In fiscal year 2023, Peloton generated $2.8 billion in total revenue, reflecting a decrease of 22% year-over-year. This decrease is primarily driven by decreasing hardware sales. More specifically, Connected Fitness Product sales were down 29% YoY at $1.6 billion, and Subscription revenue was up 6% at $1.2 billion. This trend continued into Q1 2024 as well, with Connected Fitness product revenue of $154.6 million vs $264.5 million in Q1 2023, and Subscription revenues at $415.9 million vs $370 million during the same periods, respectively. This highlights a significant decline in hardware sales, while the subscription revenues are holding strong.

The declining hardware revenues may be attributed to several factors, including reduced consumer discretionary spending as a result of the economic conditions, and increased competition from other providers in the space.

Margins

Peloton’s subscription gross margin has remained high at about 70% since 2020. While gross margin of connected fitness products has improved over the last few quarters, from 4.3% in Q1 2022 to 34.4% in Q1 2024. It is not clear if that level is sustainable. Overall, company’s gross margins have improved as they cut costs and focus more on subscription revenues. But operating margins continue to show net losses. This is mainly due to the high expenses as they restructured to cut costs and are also making significant investments in marketing and R&D to drive growth in the subscription business.

The high subscription gross margins are one of the strongest points for the business, however, the company needs to find a way to make their overall business profitable.

Cash Flow

In Q1 2024, Peloton’s free cash flow was $(10.7) million compared to $(246.9) million in the previous year’s quarter, representing a massive improvement. A combination of increase in profitability, as well as improved inventory management has helped with this. The company is focusing on controlling costs, reducing marketing expenses, and minimizing supply chain costs. However, they still have a very low cash balance compared to their total debt which raises concerns of ability to pay off their debts in the future.

Balance Sheet

Liquidity: Peloton’s cash and cash equivalents have decreased over the past couple of years, primarily due to the heavy losses and restructuring costs. As of September 2023, they had around 750 million compared to about 1.2 billion at the start of 2022.
Debt: Peloton has a significant level of debt, with total debt reaching $1.6 billion. This debt can be a significant liability especially in case they are unable to generate a substantial profit or face another market shock.
Equity: Peloton’s equity has been heavily depleted by recurring losses in the past years, with the company reporting a negative equity of 667 million.
Inventory: Peloton has had problems with supply chain, leading to high inventory levels, but it has finally come down over the last year from about 1.2 billion to 874 million. The company is continuously working on improving their inventory management to not get too much or too less, as to keep up with consumer demand.
Intangible Assets: The company holds about 3.3 billion dollars worth of intangible assets including customer relationships and software. Their software continues to be a significant aspect of their platform.
Goodwill: The company has about 237 million worth of goodwill. They have continued to conduct acquisitions in the last 2 years for expanding their reach into new markets. These acquisitions can be useful in creating competitive advantage and long-term growth for the company.

Peloton’s current balance sheet is a major area of concern. With a very low equity, a huge debt balance, and recent losses, they have no margin of safety in case of a business disruption. The management is putting in effort to reduce costs and manage the inventory, which should hopefully yield positive results. However, their liquidity still remains weak.

Understandability

I would rate Peloton at a 3/5 for understandability. The core product of the company is easy to understand, but the way they are trying to expand their business using connected fitness, subscription revenue, and software along with the financial aspects related to them are complicated. While their financials are easily accessible for public view, they require in-depth understanding of accounting principles for complete clarity.

Moat Analysis

Peloton’s moat is weak and not very clear, a strong brand and first mover advantage is their moat’s only plus point, which can be easily eroded away over time.

Moat Rating: 1.5/5

Intangible Assets: Peloton has built a valuable brand within the connected fitness space. There is a level of brand loyalty which allows them to charge a premium and retain customers better than others. However, competition in the space is starting to develop many other brands. Other than the brand, there are not any other major intangible assets which can give a durable advantage for their business. The company does not have any other proprietary technology or a monopoly market, and are also subject to legal risk if other players can patent something related to their product.
Switching Costs: While Peloton has gained a lot of brand loyalty and many consider it a premium brand, switching costs for connected fitness products is very low. It might be cumbersome for consumers to set up new equipment but there is nothing that would make it more difficult to switch between different companies. In fact, companies offer new consumers very good deals to lure them to their offerings which decreases this moat even more.
Network Effects: Peloton does not benefit from the network effects. Although the customer base has grown considerably over the last decade, the amount of connectivity that has formed between users is not as high as other social media companies.
Cost Advantages: Peloton does not have a cost advantage due to the complex manufacturing and distribution process associated with its hardware equipment. Peloton’s expenses are higher due to production costs, shipping and distribution costs, marketing, and R&D expenses. The company has tried to improve this with restructuring and layoffs, however, at present the company has no major cost advantage.

Risks

Several risks can threaten Peloton’s business and its moat:

Competition: The connected fitness market is becoming increasingly competitive, with several established brands and new entrants providing innovative fitness options that make it difficult for Peloton to retain its market share and pricing power.
Technological Disruption: Technological advancements and innovations from competitors might render Peloton’s offerings less attractive or obsolete. The company needs to keep up with new technology for their products and also develop their software to stay competitive.
Changes in Consumer Preferences: Changes in fitness trends and preferences could reduce the appeal of Peloton’s approach, as many people might prefer in-person interactions over at-home fitness.
Economic Downturn: In an economic downturn people may reduce their spending on luxury fitness items and focus on necessity items. With increased inflation, the company may need to increase the prices of products, reducing the consumer base.
Supply Chain Disruptions: The company manufactures their hardware in different parts of the world and are also subject to supply chain risks.
Poor Management While the company is working hard to make a come back, poor business and management decisions that have plagued them from previous years could continue to have an effect on the company.

Business Resilience

While the company faces several risks, they also show several signs of resilience: * Brand Strength: Peloton has built a strong brand with a loyal customer base that provides some resilience during times of market challenges. * Focus on Subscription: The company’s growing focus on subscription revenue rather than relying on hardware sales will likely help with long term profitability. * Experienced Leadership: Their new management has good experience in the retail and consumer products business. * Continuous Innovation: The company is working on new product development and also content creation, which would generate long term growth if the company is able to execute it correctly.

Recent News/Controversies

Restructuring and Layoffs: The company has continued with rounds of restructuring and layoffs to bring down costs. This is a good sign from an investors point of view that company’s management is trying to increase profitability by controlling costs.
New Partnerships: Peloton has been working on new partnerships with different companies. Most recently, the company partnered with Lululemon to offer content to their customers. This might help Peloton bring new members to their subscription ecosystem and create more value in the market.
Focus on Subscription: Company is focusing on growing the subscription revenue, as the growth in that segment has been positive despite the troubles in the hardware division. This might prove to be the core of the company’s future.
Price Hikes: Peloton has increased the prices of some of its hardware products to improve profit margins. This move will need to be watched to see how their consumers react to it.
Lawsuits: There have been several lawsuits against the company which have been a major concern for the management. They are working on resolving them.

Based on the information available, there appears to be a large amount of uncertainty and risk surrounding the business. There are also some positives as company is still in the early phase of growth. Their management is taking all necessary steps and focusing on creating a sustainable and profitable business for the future.

Summary

Peloton, while having a strong brand and the ability to cultivate a loyal user base, has an extremely weak competitive advantage, is hard to understand in terms of financials, their future profits are uncertain, and their balance sheet is in a dire condition.

Overall Ratings

Moat: 1.5/5
Understandability: 3/5
Balance Sheet Health: 2/5