Do you like to invest in growth stocks? Are you also interested in subscription-based companies? Then today we are going to talk about one of 2020’s investor favorite, Peloton!
~Very Long Post – Don’t Read If You Hate Long DDs~
We are going to take a look at their fundamental value, their DCF while we will also do a little technical analysis and get some price targets for the workout at home favorite for this year and for 2025 as I will give my opinion if Peloton still has room to grow or if this is was a one-year unicorn!
[Full Disclosure – I have no positions in Peloton, and no plans to initiate any positions within the next days]
So, what is Peloton and what do they do? They are a company that offers hardware fitness products like their Bike or Tread, but compared to your other traditional companies, they also offer subscriptions which allow you to watch live streams or on-demand classes that will help you with your home workouts.
You can also get these streaming products through their own Peloton app, which costs $13/month without any of their hardware devices, as Peloton mostly offers premium products that are targeting high end consumers, with their Tread starting from $2500 and up to $4300, while their Bikes are priced in the $1900 to $2500 price range.
They became a very popular stock in the past year as they saw a huge boost in their revenues & earnings in 2020, as more & more people switched to home workouts, though it will be very interesting to see if this trend can continue after things start going back to normal.
So, guys, let’s go through the 2th quarter results for Peloton, as they use a different financial year, starting in the middle of the year!
Peloton released the latest earnings report at the start of February in which they beat both the top line by $30M and the bottom line, as the company posted an $0.18/share profit
The revenue generated in the last quarter and the number of connected subscriptions grew by over 120% year/year, which was hugely boosted by the events we saw in 2020.
Peloton has 2 main streams of revenues, the connected fitness products and the subscriptions revenues.
You can see here the company made just over $1B in total revenues in the last quarter, which was an increase of 29% over the last quarter, continuing the uptrend started in 2020.
Peloton saw an increase of 45% in revenues from connected fitness products, even though they are still facing big delays in delivering their products to customers, with both bikes and treads seeing delivery time of over 6 weeks even now.
I believe this revenue stream growth will likely peak this year, which I expect to be the last one where workouts at home are the nr.1 way to stay in shape.
Meanwhile, their other revenue stream, the subscriptions revenue, has increased over 240% over the same period in 2019, and has increased 23% over the previous quarter.
On the other hand, their cost of sales for both the hardware products as well as the subscription services has pretty much stayed the same, hovering over 60% for the hardware equipment and around 40% for the subscription services.
I don’t see how they will drastically improve this, so I will just slightly increase their margins by 1%/year for both revenue streams.
The other operating expenses are also pretty significant for the company, as they use over 13% of their revenues for General & Administrative purposes.
Peloton also invests 4.5% of their revenues back into R&D to continue to stay ahead of the competition, while the biggest chunk of the OpEx goes to sales & marketing which accounts for over 16% of their total revenues.
The company does have decent financials with over $2B cash, cash equivalents & marketable securities which can easily pay off the current and long-term liabilities of the company which stand at just under $2B.
Peloton has increased their capital expenditures in the past year, spending $120M in the last 6 months of 2020 compared to under $50M for the same period in 2019, and this will continue to increase, as they have a pending transaction to acquire Precor for over $400M in cash.
The company has continued to increase the depreciation & amortization expenses, which will have a positive impact on their EBITDA, while on the other hand, they have pretty insignificant other incomes & expenses on their bottom line, with just $1.8M added to the bottom line in the last quarter of 2020.
Not all companies do, but Peloton gives pretty detailed data which allows us to easily calculate the net working capital of the company for the DCF numbers, though you should always dig deep through the financials as Pelton has once major problem, which is the share dilution of the company.
We can see HERE , the company has almost 300M shares outstanding, but the bigger problem is that they have massively increased the number of shares available, up from 160M in 2019 and are planning to continue to dilute their stock as they are giving out a big number of stock options for their employees, with over 50M shares just in the last 3 months of 2020
This stock compensation plan is based on their 2019 equity incentive plan, which continued after their 2015 plan. In this plan the company allows up to 5% of the total outstanding shares to be granted until 2029, which will continue to add pressure to the price of the stock
The other risk factors that the company mentioned are the increasingly competitive market they operate in, a possible decline in their Bike & Tread sales and of course the supply chain issues, which have affected the company for the past year.
The company itself points out the fact that they just become profitable in the past 2 quarters after losing money in each year since their inception, but provided an upbeat guidance for Q3, as they expect to continue to add additional sales regions for their products in 2021, while also closing the deal with Precor, which will help them in their manufacturing process
So, folks, taking into account the financials of the company, their outlook and my own projections for the growth of company I made some predictions, but please remember, this is not investment advice & do your own Due Diligence before investing!
Let’s start with the discounted free cash flow projections to see what the current valuation of the company is.
I started from their current earnings before interest & tax which stand at 7% of their revenues currently. I implied a 2% annual growth for this, as the company will become more profitable as they scale up their business.
The company has a very short history for their effective tax rate, which was way below the 21% US tax rate, but given that most tech companies manage to get substantially better effective tax rates, I think a 15% for Peloton is realistic.
I also added back their D&A for which I implied the same growth rate as the one for their revenues, but we will discuss the revenue growth in a couple of minutes.
Peloton will need to continue to invest in Capex to be able to scale up their business, while their net working capital is expected to decline as they will slowly start to build up inventories after the huge supply crisis that they faced starting in 2020.
So, folks, for an 9.5% discount rate, which is what I will use for the moment, we get just over $3.6B in discounted free cash flows by 2026. This rate is a combination of the average sp500 return and the current yield of the 10year Treasury bill which stands around 1.5%.
As always, there are 2 methods of doing the valuation from here, the EBITDA multiple valuation, for which we get a $152.5 price target and the Perpetuity Approach for which we get a $100 price target.
You might be wondering why I used a 19x EBITDA approach for Peloton, well I chose an average between the 25x multiple for Technology and 14x multiple for the fitness industry.
Folks, I wouldn’t pick one or the other valuation, so I like to use an average approach, which would result in a PRICE target of $126.58 or a 17% upside for the stock in the next 12 months
Given all of this, I think now is the time to move on to a longer-term valuation of the company based on the growth projections I have for Peloton.
I believe we can continue to see a significant growth for their sales of fitness products in the next years, but this growth will slow down in the future, as we slowly get over this stay-at-home environment, even if we never fully go back to the way things were.
I believe the bigger growth stream will come from their subscription service, as they continue to improve the products they offer, including their Peloton App which doesn’t even require you to own their hardware.
For the cost of sales, as I said previously, I only implied a 1% annual improvement of their margins on both revenue streams as I also maintained their average from the previous 2 years regarding the other operating expenses like SG&A and R&D.
Given these numbers & projections, we get a gross profit for Peloton of just over $2B by 2025. But there are many other things that we have to take into account like the Capex spending, which I believe will continue to see an increase of at least 5%/year and the interest & other income & expenses, which for Peloton are pretty insignificant.
So, the bottom line I think we will see for Peloton in 2025, including an estimated 15% effective tax rate is just under $1.7B.
The last important thing to take into account when doing long-term valuations is how the number of outstanding shares will continue to evolve, and in this case, I believe we will continue to see at least a 5% dilution for Peloton stock in the next years, which would mean by 2025 we would see almost 356M shares.
So, after all these estimates what are my price targets for the company in the long-run?
I always like to value companies on future P/E multiples, so, with a $4.69 EPS and depending on what P/E multiple you chose between 25 and 40, we can see the stock can trade in a range between $117 and $187.
We should also always take a look at what other analysts estimate for the stock, and we can see, there is not much coverage on the stock, but the other analyst predicted an even lower EPS by 2025.
Folks, my final price targets for Peloton by 2025 range between $129 for the Bear case, $152 for the base case and almost $176 for the bull case, implying gains between 19% and up to 63% on the stock, which I believe are not that interesting, as you can usually get similar returns by just investing in index funds, ETFs ore other stocks with much lower risk factors.
So yeah guys, these are my OVERALL price targets for the next 12 months and for 2025
But now, you are probably wondering, what do I expect in the next couple of days, weeks and months for Peloton?
Let’s start by looking at this CHART. We can see Peloton was trading on huge volumes towards the end of last year with 30-40M shares/day on multiple occasions, which we saw again once the Precor news popped up.
Since that moment, the stock seems to have fallen out of favor, as the volume has consistently stayed below 10M shares/day. The stock is pretty oversold right now after the recent sell-off caused by the spike in treasury yields, but has a decent support line near the $108 levels, though I believe it will face major resistance to break $138 again given the fact that no major catalysts are expected soon, as most of the earnings and revenue growth is already priced in the stock price.
Folks, I always check what other wall street analysts think of the stock, and it seems in this case they are massively overvaluing the company in my opinion with 23 bullish ratings and just 2 bearish views, with an average price target of $165.
So, are you asking yourself, what would I do?
Well, I would mostly stay away from this stock, as I believe there are far better opportunities out there in the stock market, but if you like you can nibble a little and buy some Peloton after this big sell-off, as the stock is down a lot from its all-time highs.
Yeah guys, these are my projections and my expectations for the company, I think Peloton will struggle to enter households with more than 1 of their products, as you can see, only 3% of their customers use both a bike and a tread, which given the huge price tags of their products is understandable.
I also believe the big % of people that are paying month to month their Peloton subscriptions is another reason for concern, as people are much more likely to ditch those once normal gyms become more attractive once again, and as you can see HERE, the trend was not working that much in their favor before 2020, with modest increases in fitness subscriptions & quarterly workouts, while their total revenue and average monthly workouts were even going the wrong way.
And finally, after comparing my projections to Peloton’s own guidance, which is way lower than my predictions, it’s obvious the company itself doesn’t expect this insane growth to continue, and even if they do continue to expand in multiple countries, not many countries outside the US will really enjoy their products which are very expensive for most of the countries in the world.
Thank you everyone for reading Hope you enjoyed the content! Be sure to leave a comment down below with your opinion on the stock market! Have a great day and see you next time