It’s been a tough start to the year for Peloton (PTON), with the company’s rally last month getting derailed by an underwhelming fiscal Q2 2020 earnings report. While fiscal Q2 2020 revenue hit a new record high at $466.3 million, this was still not enough to prevent a quarter of massive sequential deceleration in growth rates. Unfortunately, this deceleration is not a single quarter anomaly, with the two-quarter average revenue growth rate expected to drop another 3,000 basis points by fiscal Q1 2021. Based on this significant slowdown, continued deceleration in subscriber growth, and a valuation unfit for the industry Peloton is in, I continue to see the stock as high risk at $29.00 per share, and I see the stock as an Avoid.
January was an exciting month for Peloton investors, as those holding the stock enjoyed a brief period of market outperformance, with the stock putting up a 14% return for the month. However, the revenue beat of $42 million in the fiscal Q2 2020 earnings report was not enough to evade massive deceleration. To make matters worse, guidance going forward is forecasting an even further slowdown as we head into the back half of FY-2020. Before digging into the growth metrics, however, let’s do a quick summary of new developments in the quarter:
Peloton had a busy quarter, finishing fiscal Q2 2020 with 712,000 connected subscribers, and forecasting a mid-point of 925,000 connected subscribers to finish FY-2020. While this would reflect 81% growth year-over-year as the chart above shows, this is a more than 2,000 basis point decrease sequentially from the FY-2019 growth rate. This isn’t alarming as any business is going to get harder to scale as it grows. Still, it’s a little less impressive when factoring in that Peloton has dropped its digital subscription price from $19.49 to $12.99 in the quarter, a price decrease of over 30%. Given the much lower price point at less than the cost of Netflix (NFLX) premium ($15.99) per month, I would have expected more ambitious guidance for FY-2020. The other issue is that the company is guiding for a 20 basis point increase in churn for FY-2020, from 0.74% at the end of fiscal Q2 to below 0.95% for FY-2020. Given a price drop of over 30%, I would have expected churn to have decreased or stabilized, not been guided slightly higher.
In terms of profitability, the company’s net loss widened year-over-year in Q2, from $55.1 million in Q2 2019 to $55.4 million in fiscal Q2 2020. While this isn’t a significant jump in losses, it’s occurring despite double the amount of subscribers. The company has noted that it could be profitable at any time, but its focus is on subscriber growth over profitability. While this makes sense as the company has an advantage and a head-start vs. potential competitors in the space, this also deters some growth funds from owning the stock. This is because many growth funds want positive earnings per share before establishing meaningful position sizes. Therefore, while the company plans to be profitable by FY-2023, I believe more balance between growth and profitability would make a little more sense. Netflix was one growth stock that consistently put growth over profitability in its earlier years, but garnered much more attention and a more extensive institutional following in FY-2013 when it became profitable and started to balance the two better. Let’s take a look at the Peloton’s growth metrics below:
As we can see from the below chart of annual earnings per share [EPS], Peloton continues to post net losses, with a net loss of $0.69 per share in FY-2019, and estimates for a net loss of $1.01 per share in FY-2020. If we look out further to FY-2021 and FY-2022 forecasts, it’s highly unlikely that the company will be profitable by then, with net losses expected to narrow only slightly. Based on the fact that the company has zero earnings to speak of, the only real way to value the company is by revenue growth. Unfortunately for Peloton, while revenue growth rates remain robust, we’ve started to see material deceleration since the company went public.
If we take a look at the chart below, Peloton has seen a steady trend lower in revenue growth rates but managed to avoid further deceleration between fiscal Q2 2019 and fiscal Q1 2020. This was extremely impressive as it suggested that the company might be seeing sales growth trough out at low triple-digit levels. Unfortunately, the most recent report has put a significant dent in any hopes of this, with the fiscal Q2 2020 revenue growth rate decelerating from 103% to 77%, a more than 2,500 basis point sequential slowdown. This is quite worrisome, especially given the lower-priced digital subscription and minor deceleration in connected subscriber growth going forward.
I like to use a two-quarter average for revenue growth rates as it helps to smooth out any lumpy quarters and better dictates the overall trend. As we can see from the trend in the two-quarter average revenue growth rate (white line), this deceleration is not a one-quarter anomaly. While the company was seeing a minor slowdown in the most recent quarter (106% vs. 115%), the drop-off in fiscal Q2 2020 was much more pronounced, with a 1,600 basis point sequential deceleration. This suggests to me that triple-digit revenue growth rates are a thing of the past, and it’s highly unlikely the company will ever return to this growth.
If we look out further to fiscal Q3 2020 estimates, analysts are currently projecting $494.1 million in revenues, while the company has guided for $475 million in revenue at the mid-point. I prefer to use the estimates as the company has proven to be conservative in its guidance, evidenced by the $40 plus million beat in its most recent quarter. However, even if we go by the guidance of $494.1 million, this figure only translates to 56% growth year-over-year, yet another sequential deceleration of more than 2,000 basis points. The company noted in the recent earnings call that Q3 2019 was unusually inflated due to slower delivery times, and therefore, investors should be less critical of the perceived deceleration. The reason for this is because the company recognizes revenue when the delivery has taken place. Therefore, management’s point is that they are up against unusually strong comps in fiscal Q3 2019. While this is a fair point, it’s not solely fiscal Q3 2020 that’s looking like an issue. Based on estimates, we have 60% growth forecasted in fiscal Q4 2020, and forecasts for only 49% growth year-over-year in fiscal Q1 2020. Based on this, I do not see this argument as a reason to discount the deceleration we’re seeing.
While earnings estimates are not set in stone, Peloton is going to need to put up a massive beat to prevent another consecutive quarter of massive deceleration. My classification for material deceleration is a 500 basis point or greater slowdown sequentially. When it comes to classifying massive deceleration, this would be a 1,000 basis point or more significant slowdown sequentially. To prevent massive deceleration (1,000 basis points or higher), the company will need to report fiscal Q3 2020 revenue of $532.1 million. This figure is $38 million above current estimates, and more than $57 million above the guidance provided by the company. There is always the possibility that the company could somehow achieve this; however, it’s not going to be an easy task. This is especially true with digital subscriptions now at a 30% lower price point. To summarize, from a sales growth perspective, we are likely to see the two-quarter average revenue growth rate slide from 90% in the most recent quarter to 60% or lower by fiscal Q4 2020. This is a 3,000 basis point slowdown and should provide a headwind for the stock going forward.
It’s important to note that deceleration alone is not enough to unhinge a growth stock, but it certainly does make it riskier. Instead, what does have the ability to hurt a growth stock is material deceleration that’s combined with a valuation that’s above fair value relative to peers. As Citron Research’s December short report points out, Peloton was briefly trading at an enterprise value per subscriber of $15,631, more than 2,000% above the peer average of $655. The peer group is made up of companies like Planet Fitness (PLNT), Fitbit (FIT), Roku (ROKU), Netflix (NFLX), and a few others. Fortunately, this metric has come down a little after the sell-off in Peloton and the added subscribers in fiscal Q2 2020. However, this figure still stands above $10,300 per subscriber, more than 1,500% above the peer average.
If we give Peloton the benefit of the doubt and only measure it against the top three highest valued figures among this peer group, being Match (MTCH), Stitch Fix (SFIX), and Netflix, this still doesn’t make the valuation any more palatable. Against this peer group, which has an average enterprise value per subscriber of $1,268, Peloton is still more than 800% above this level. Therefore, while Peloton may deserve a premium valuation for being the new kid on the IPO block, a premium this large is nowhere near justified.
If we move over to the technical picture, there’s not a ton to like here either, with the stock falling back below its 50-day moving average after clinging to life above it the past several weeks. This drop back beneath the 50-day moving average (pink line) suggests that short-term momentum is back to the downside, and this is not encouraging for traders or investors. The reason for this is that the next key support level doesn’t come in until $29.15, more than 20% below current prices. Given the fact that strong resistance sits 25% higher at $34.80 and support is just over 25% lower near $21.15, there’s no real reward to risk proposition buying in the middle of this range with negative momentum. Therefore, from strictly a trading or investment standpoint, the stock is also high-risk, high-reward.
Peloton is the first mover in an industry that is snowballing, but the deceleration in both subscriber growth and revenue growth rates suggests that the best days of growth are likely over. Even if we use the high end of forward estimates for the next two quarters, it is highly likely that Peloton’s two-quarter average revenue growth rate will slip to 60% by fiscal Q4 2021, down 3,000 basis points from current levels. This is an alarming slowdown in growth rates, especially for a company with an enterprise value per subscriber that’s nearly ten times its peer average. For these reasons, I continue to see Peloton as an Avoid and see no reason to pay up for the stock. While the stock could bounce in the interim, I would not be surprised if Peloton re-tested its support level near $22.00 at some point this year.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.