today is May 20, 2022

The pandemic changed many things about the business world. For some companies, the government lockdowns and stay-at-home orders crushed consumer demand. For others, the pandemic provided a great boost for their products.

At-home exercise company Peloton (PTON -4.93%) fell in the latter category. Demand surged during 2020 and early 2021, with revenue exploding higher as people wanted a new and fun way to exercise at home. 

But now, over two years after the pandemic started, demand for Peloton's products has dried up, sending the stock below its IPO price. But for investors looking at buying Peloton shares, it is not about what the company is doing now but what it could be doing in the future.

Where will Peloton stock be five years from now? Let's take a look. 

A person riding an exercise bike.

Image source: Getty Images.

The rise and fall of a pandemic winner

Peloton went public in late 2019, right before the pandemic started. As you can see from the chart below, revenue growth was nothing to scoff at before the pandemic, hovering at around 100%. Wealthy people were enamored by the expensive and nice-looking exercise bikes that cost more than $2,000 at the time along with the monthly subscription to online exercise classes.

However, the pandemic lockdowns kicked the business into overdrive.Revenue growth accelerated in 2020 and peaked around a year into the pandemic at close to 240% year-over-year. For the fiscal year that ended in July of 2021, Peloton's revenue grew 120% to $4 billion, which is music to most investors' ears.

But with this growth came steady operating losses, at $188 million in fiscal year 2021. Even at a scale of $4 billion in revenue, Peloton struggled to achieve profitability because of the low gross margins of its fitness products and large spending on sales and marketing.

This became a huge concern when pandemic demand dried up in the past few quarters. In the last quarter covering the key holiday season, Peloton's revenue only grew 6% year over year and net losses ballooned to close to $500 million. The company, which was thriving during the pandemic, faced a slight risk of bankruptcy if it didn't turn around the business -- which is exactly what the board of directors and some activist investors decided to do.

PTON Revenue (Quarterly YoY Growth) Chart

PTON Revenue (Quarterly YoY Growth) data by YCharts.

A turnaround team is in place 

January 2022 was a chaotic time for Peloton. On Jan. 20, CNBC reported that demand for the bikes and treadmills was so bad that the company was going to halt production. This caused the stock to tank 20%, and on Jan. 24 an activist investor swooped in with a recommendation that the board of directors fire founder and CEO John Foley.

And that is (kind of) what the company did. On Feb. 8, Peloton put out a press release outlining two changes to the executive team. First, Foley would be out as CEO and bumped up to the Executive Chair of the Board of Directors. Second, to replace Foley, Peloton would be bringing in Barry McCarthy as CEO. McCarthy is a highly experienced executive who has worked as the chief financial officer at both Netflix and Spotify.

In conjunction with the leadership change, Peloton put out a press release outlining how it will "rightsize" the business. Key points include:

  • Canceling construction of Peloton Output Park, its manufacturing hub.
  • Optimizing its logistics network with third-party relationships.
  • Laying off 2,800 employees, including 20% of its corporate positions.

These initiatives will save $800 million in annual operating expenses and reduce 2022 capital expenditures by $150 million. It is a tough pill to swallow, but it likely keeps bankruptcy off the table for now and gets the company on a trajectory toward positive cash flow.  

So where will Peloton be in 5 years?

Peloton stock is now in a drawdown of 88% and trades at a market cap of $6.7 billion. There is a lot of uncertainty around the future of this at-home exercise business. But if Peloton is going to be a good stock to buy on the dip here, there is one thing investors need to be confident in: growth of its connected fitness subscribers.

Connected fitness subscribers are people that pay monthly subscriptions for Peloton's workout classes, ranging from $13 a month for just the mobile application to $39 a month for the all-access membership. As of the end of 2021, the company had 2.77 million connected fitness subscribers, growing 66% year over year. This revenue also has high gross margins of 68%.

Assuming the new cost-cutting measures can get the hardware business to break even, the true value of Peloton's business will come from this subscription revenue. Last quarter, subscription revenue came in at $338 million, or $1.35 billion on an annualized basis. If this segment can grow revenue at 20% a year for the next five years, it will be doing $3.37 billion in annualized revenue at the end of 2026. This equates to a 2026 price-to-sales ratio (P/S) of 2 for the subscription business based on the stock's current market cap. 

These are a lot of numbers and estimates, but what it really means is that if you believe McCarthy can stabilize profit margins and continue to steadily grow the subscription business, Peloton stock could be much higher five years from now. If you don't believe the business is salvageable, then it is best to stay away from buying the dip here.