Chit Chat Stocks - Peloton (PTON) | Fundamental Analysis

Episode Date: November 15, 2020

Peloton is the pandemic exercise sensation. Ryan and Brett analyze the company this week and discuss the potential Peloton has going forward. We stick to our normal schedule, Ryan gives the business overview (1:22), Brett covers the valuation (4:35) and Ryan discusses earnings (5:56). On the second half, your hosts discuss their favorite segments, digging trenches (8:18), further readings (9:38), future growth opportunities for Peloton (11:46), highlights and lowlights (14:41) and finally more or less interested (18:35). As always enjoy the episode! Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Watch this episode on YouTube: https://youtu.be/Ye5r0o2WfHw Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Visit our website to see more from your hosts Ryan and Brett. https://www.chitchatmoney.com --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Fundamental Analysis Show, our Sunday episode where we go over a stock and help you learn about it in 20 minutes. But before we get to Peloton, our company today, I'm going to throw it over to Ryan to talk about our friends at 7investing. Oh, right. Yeah, we have our coupon

code CCM. Promo code. Promo? Yeah, whatever. But you get $10 off your first month and it's normally 17 bucks so you're getting all their picks dating back to whenever they started for literally seven dollars so it seems like a no-brainer but i mean that's from us and we get a kickback so yeah we love feel free to support us yeah if you want to support the show in any way and also get a quality product while you're doing it you can go to seven investing and yeah use the discount code ccm but let's get to the show we're talking peloton ryan do you want to introduce the company Yeah, so I feel like most people know who Peloton is or what Peloton does, but they're an exercise equipment and media company. They describe themselves as the world's largest interactive fitness platform. So basically they have two fitness hardwares. Well, I guess there's different iterations of both now, but they have the bike and the treadmill. and then the bike if you've never seen this it's sort of it's a stationary bike and it has what

looks like an ipad on the face of it so that you can watch classes on it and the bike costs around two thousand dollars i think it's like 1890 or something like that and you can finance the bike purchase over 39 months with zero percent interest and the classes cost around 39 a month so the classes are more of a subscription and you get like virtual interactive classes there's other people that are taking the classes at the same time you can see how well you've done it's like actually a pretty competitive atmosphere it feels like um i don't know like a huge cycling class if you've ever done that yeah there's a big community aspect to it right and then the treadmill i believe is similar but the bike's much more popular bike's gotta be 90 plus the revenue

yeah and then uh as far as history goes in 2011 john foley was an executive at barnes and noble and he was invited or sorry he invited his former colleague tom cortesi or i think it's maybe cortese uh over for dinner and he pitched in the idea of what peloton would be the two agreed that some sort of bike with the screen for virtual classes would be a good idea so they got four hundred thousand dollars in seed funding for a few angel investors that's not a lot of money fyi for a company like this no yeah and uh over the next year they built a prototype with a few other co-founders so all they had was one prototype a name and a few guys and they ended up building up this business and they had a lot of trouble getting investors because no one liked the idea

of just a hardware business which was just a cycling class at home and that's what investors saw it as little did they know it would become the business that it's become today but because of them having so much trouble getting funding john foley has roughly 30 of the business still he owns that wow and the other executives all together i think they make up like 58 percent of all the voting shares wow that's a lot that's a lot it's huge that's uh it's big before i mean they're gonna be if the company works out they're gonna be very very rich and it's also good because they have the incentive uh to align themselves with shareholders yeah and they were not uh so they weren't very diluted down prior to going public um and i might be getting they had i know

john foley had 30 of the voting shares okay so there might be a dual class there is a dual class but it said like combined total voting power was 30 okay okay that makes sense and the reason people doubted them so much is because typically hardware businesses have trouble and the only one that's really had success over the long term is apple but in reality people compare peloton to apple a lot where it's like well it's not that much different but the brand um i guess matters a ton and they've able they're able to uh you know beat the stereotype of hardware businesses being bad but i'll get into the valuation next ev or enterprise value is 27.8 billion as the time of recording we understand it's been a volatile week so really check up on what the enterprise value or market

cap is trading at currently it could be a few billion different by the time you hear this their ticker is pton ev to sales 11.8 no dividend no buybacks they're in full growth mode ev to gross profit is 27 so you know expensive but not crazy that's what i'd classify it as you know if we look at the earnings that ryan will get into you can see that they probably deserve a premium valuation how much an investor has to decide margin adjusted ev to sales which is what we do where we take ev divided by gross profit or sorry gross margin and sales growth um that is 11.8 which is really low and driven by the trailing sales growth being super high up in the triple digits and that's likely not going to be repeatable but again the high revenue growth could really

help them get to a sustainable valuation quickly um just you know it's not a guarantee that's the thing yeah i think some people look at the triple digit revenue or top line growth and think it's gonna like stay that way forever it obviously can't so that doesn't make it a bad investment just because growth slows you just have to expect to come down to the double digits right eventually But I'll get into the earnings then. For the first quarter of 2021, revenue was $758 million, up 232% year over year. 79% of that revenue is connected fitness. So that's like the purchases of the bike. And then 21% is subscription revenue. This quarter, they had 77.8 million workouts. So amount of people that worked out. No, sorry. Not amount of people. Amount of workouts done by their subscribers. That's not a financial metric. That's just usage or whatever. And that was up 306% year over year. So it's kind of showing that people are spending more time on the platform. And then they had 1.3 million connected fitness subscriptions up 137% year over year, 43.4% gross margins, although subscription gross margin is 58.5%. five percent i think the goal is that subscriptions start to make up more as this uh as peloton gets

later on to their life cycle but obviously even if people are subscribing to it if they are doing really really well and selling more bikes it's hard for subscriptions to make up a majority of the top line i think yeah they just wanted to both grow at the same time right now yeah and then they had 69.3 million in net income 119 million in adjusted ebita two mil or two billion in cash and cash equivalents, and then their operating cash flow margin was 41.1%. That's a pretty interesting, that's an appealing number. Yeah, I think there must have been some one-times things. I tweeted out that, yeah, they had 312 million operating cash flow. Looking at that enterprise value, it doesn't seem crazy, but there's some things on there that

likely attributed to that happening, whether it was inventory, something like that, that wouldn't be repeatable. So that's a good number, but we'll see what happens over a trailing 12 month period or the next few quarters here. And then one thing I forgot to mention on the balance sheet is that they have no big liabilities outside of their long-term lease liabilities. And then some other liabilities are deferred revenue. But if you think that people are going to continue to subscribe and keep their bikes and not send them back, they should be fine. Did you check any of the stock based compensation numbers uh not bad this quarter it was 29 million okay so not crazy but not zero it's just something obviously with a company like this to watch out for

cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply okay welcome back first up now is digging trenches what do you think here does peloton have any sort of moat any competitive advantages i'm gonna go and this might blow your mind i'm gonna go with a three a full-blown moat i think it's incredibly sticky i think the community aspect has driven people to stay on

and anyone that i know that has a peloton we talked with richard chu last week they love it which usually when you have raving customers it builds some sort of retention and stickiness i mean people have tried to launch competitors but there's a massive network effect with peloton business as influence influencers come to the business as more people flock to being a peloton member the next one it's incrementally the value of joining is higher yeah and then maybe before the pandemic people would have thought all right there's room for a competitor to step in but now with them just accelerating their business so much they may have hit escape velocity where not even someone like a big tech company unless they invest billions and billions of dollars they're not going

to be able to compete with peloton now does that make the value you still have to take into account the valuation things like that but does the business have a strong moat i'd agree maybe like 2.5 um but it's definitely high and that's one of the reasons people are very very bullish on peloton what are you looking at for further reading further reading uh how they plan to incorporate non-cardio activities it seems like a tough problem to solve do they want to steal lifters from the gym or are they just trying to add people who didn't go to the gym beforehand uh is that the market they're going after you know you can't implement a squat rack you can't have a dumbbell set in uh in someone's home you know you have to get a little bit innovative on

there uh do a you know some sort of way to solve problems are they gonna have bands or all the different types of things so it's kind of tough um sort of acquire those type of people but if they can get them on the subscription uh you know software whatever it is that's i mean that's a whole other market to go after that's just as big as the cardio one yeah and i think that's sort of what mirror the company that lula lemon acquired right is going after and maybe i'm wrong but their bike plus i believe the screen can turn so i think you can kind of use that as sort of like a mirror type thing where if you're doing at home band workouts something like that maybe they move into that market maybe they already have i haven't really looked into that

But yeah, that's definitely something to look forward to. And then for me, I'm looking at the success of the upgrade cycle. So like I said, they recently launched their Bike Plus. So it's about $500 more than their original bike. And I'd love to see in coming quarters on the conference call if they mention how successful this has been. because if we're seeing a lot of people that originally owned the normal bike and are upgrading to the bike plus i think the apple comparisons are warranted they're actually warranted yeah because it's kind of like the iphone iphone pro thing and even though maybe someone comes out with

a technically superior product uh than peloton like a samsung uh the brand value of the apple or peloton actually you know people are like oh brand value it's just hardware with an ipad um i mean apple that's apple's entire business so yeah and it's maybe i'm wrong but it is the most expensive business in the world or most valuable oh yeah one of the three it changes all the time uh future growth opportunities what do you have okay i'm sticking with the same theme strength training they said strength workout usage is up 500 year over year and it will be interesting to see how they work around the equipment like i said you know no squat racks no machines no full dumbbell racks but i mean with the video offerings with the mirror things

there's ways they can go about it they can attract people to get these digital memberships without having to get the bikes or the hardware because i know at least my style of working out and your style of working out we like to do like you know more of the resistance training type things yeah um and if you could have that value proposition for people like that i would consider signing up and i know there's probably millions of other people out there that would yeah i agree And I think that's sort of going after all those like 30 to 40-year-olds that signed up for P90X, whatever it was, 10 years ago and sort of replacing that. And some people make the argument that it's like, well, what about like the heavy lifters? I'm like they're never – they're never going to do this.

And in reality, there's not that many of them. Right. And maybe they incorporate some form of cardio into it and they could get a Peloton too. But they're like that's not who Peloton is going after. So it doesn't really matter. Yep, yep. um and then for me i'm looking at uh they're starting to partner with influencers so this morning they just signed a partnership with beyonce and so we're recording this way early

i think it's a week early yeah so uh for training days it's probably been a week since this was announced but on their investor relations announcements they stated peloton the world's leading interactive fitness platform which are you referring to yourself in the third person yeah no companies do that it is strange and grammy award-winning global entertainer and entrepreneur beyonce today announced a broad multi-year partnership rooted in the celebration of music a central component of the peloton class experience and pro social initiatives and i'm not sure exactly what the partnership details because uh they said it was broad and i'm not sure if she's like teaching classes but she has been a member for a few years

and i think the more people that you can sign on that are influencers it starts to become like a really expensive social media platform yeah sort of sort of i mean the integration with like instagram stuff people can easily see that adjacency um but i mean i think in reality peloton has a lot of money they can give beyonce a lot of money and then that that marketing spend um if she you know is able to acquire listeners or not listeners excuse me i was thinking of music uh acquire members that's great it's all worthwhile and wouldn't you i mean wouldn't you feel more inclined i guess maybe not beyonce for us but like if you're competing against wasn't rory mcelroy on there or something yeah i see i think jeff mack tweets about it how he competes

with rory mcelroy because he's a golfer and he invests in peloton doesn't it like just make you kind of want to join the platform yeah if i was a biker or like a spin class person i see no reason why i wouldn't be on it on peloton okay highlights and lowlights what do you have okay uh the rapid growth that they've gotten here has shown that they can achieve operating leverage um once once they get to scale it feels realistic they could get to 20 free cash flow margin i know you had the gross margin currently in the low 40s but with the if digital members become a larger percentage of revenue that should inch closer to 50 over time um you know if connected subs can grow up to 25 million plus that should be a lot of high margin revenue there and there should be operating

leverage uh to hopefully increase those margins that's really what matters to an investor over time uh low lights for me ceo did lie about the profitability pre-ipo he said we're surprisingly profitable and then the s1 came out and they were hemorrhaging money at the time so um that was a red flag to me although internal metric yeah he could have been talking about their unit economics but that does concern me a bit although um might have just been one slip up you know everyone can make a mistake uh another low light for me though is it's a very popular stock i don't like to i don't like to hopefully something i invest in becomes popular over time because it does well i'm not too interested in something that has gone up 200 although sometimes you know that's

warranted you got to balance those things out um and i'm not sure once gyms open up fully if they can still be operating cash flow positive uh this boost may have just you know been a one-time cat It doesn't mean the business is bad, but it doesn't mean that profits are here to stay in a normalized environment. I want to see if they can still generate those operating profits. I will burst your bubble a little bit. Most gyms are open. And we are in Washington, which was a pretty locked down state. Some of them are like a little socially distanced, but most gyms are operational.

Okay, when – all right, when gyms are normalized and everyone isn't – Everyone's confident to go back. Confident to go back. Yeah, that's what I mean. Yeah. I mean, my highlight is that when this vaccine news got announced, they got ripped apart. I don't think this is a stock or this is a business that customers run away from when COVID ends. I would say Zoom, like there are plenty of companies that their shift to digital was temporary. I think Zoom is maybe one of those. I think we did hit peak Zoom during COVID and we're

still probably in peak zoom i would say peloton is not one of those i think the convenience uh the customer obviously the customer enthusiasm for the product makes me feel like they're here to stay um and then the recurring revenue model will the subscriptions over time i assume unless the hardware continues to sell at triple digit growth rates uh will start to make up more of the top line making obviously higher margin so good operating leverage there um and i guess so Sorry, another low light is the fact that the hardware revenue may disappear slowly. They might not be getting growth from that, and that could slow down revenue substantially. That could scare investors.

That's something that could happen. Yeah, it's something there. I don't know. I feel like I'm reaching for low lights with this business. So I guess the one that I have is a heavy portion of their management is from Barnes & Noble. Maybe they learned their lesson. Yeah. I mean, maybe you coming from a losing company might actually be more valuable than coming from a winning company because you've learned a lot of lessons on what to avoid.

But I believe like 42% of the company is owned by Barnes & Noble's old CEO and then John Foley, who was an exec at Barnes & Noble. But I'm really reaching there. That's like all suspect. Yeah, I guess you could say that churn may increase once things get normalized, but that's just something to watch out for. I'm not confident that churn will increase, and if it even does slightly, I mean, it doesn't make the business bad. Yeah. All right. More or less interested? I'm definitely more interested, especially when the valuation has come down. Something to look at. Again, I worry about them being such an efficiently traded stock, although the consensus can lead to the 10% drop that possibly would have been unwarranted.

But yeah, it being so popular does concern me, but there's no concerns about the business. I could see why a lot of people love this company and the valuation, if you believe in the community aspect, if you believe in the competitive advantages, And if you believe in the software sales becoming larger over time and their ability to get to 25 million plus users, I mean, sounds good. There's nothing wrong with that, and I'm definitely more interested. Yeah, I totally agree. And I hate to make short-term predictions, but I think they're going to blow Q4 or the Christmas season out of the water. If any inventory indicators are there, you know. yeah yeah i mean think about all the people that are buying this that are working i don't know for

friends family that kind of thing i've heard that a lot of people re-gift the bikes really which seems weird but i want to be a re-gifter i know but seinfeld episode but 20 to 30 free cash flow margins on an ev to sales of 11 yeah like but i mean that's potentially potentially right i mean that could be a huge right now it's 40 operating cash flow margins obviously that might have been a one-time flip yeah but i i don't know i love the business yeah the let's see i mean another anecdotally a lot of people are ordering pelotons and you see them in the fintwit community they're saying that uh the orders are not coming for another three months or so you could barely get them in time for christmas so that's that's gotta be a good thing right yeah and i have heard

the argument before that people like well it's still a hardware business and it's like some of the hardware isn't a bad thing like it might be naturally a little lower margin than software but some of the best businesses of all time are a blend of hardware and software yeah yeah and the hardware you have to have a brand i mean dell you know nothing can happen there uh when something like that changes but yeah we're good to go anything else no that's it okay that's going to do it for this episode as always remember to use our seven investing promo code ccm for ten off your first month remember we are not financial advisors anything we say on this show is not formal advice or recommendation give us any recommendations for new shows to do by emailing

us at chit chat money podcast at gmail.com or if you're on twitter dm us at our chit chat money feed those will be in the show notes as well thank you all for listening we'll see you on our next episode Thank you. this family is on the brink of civil war on september 18th mob land the hit original series is back on paramount plus we are the harrigans don't know the net and google us from the underworld of guy ritchie do you want to step up the ladder i want karma dead starring tom hardy pierce brosnan and helen mirren do i have to do everything myself

New season hits September 18th on Paramount Plus.