It’s an extremely rare occurrence for the stock market to have two consecutive years of negative returns. In fact, the last time this happened was roughly 20 years ago during the dot-com bust. This bodes well for the S&P 500 and the Nasdaq Composite to make a bull run this year. Both are up so far in 2023.
If investors start to adopt a risk-on sentiment this year, a company like Peloton Interactive (NASDAQ: PTON) could soar. With shares already up 31% in 2023, this consumer discretionary stock might just be able to supercharge your portfolio. But there are lots of challenges.
Making progress toward a turnaround
Many readers are already familiar with Peloton’s fall from grace. The previous leadership team, led by co-founder and then CEO John Foley, essentially overinvested in the company’s manufacturing and distribution capabilities, hoping that the pandemic-fueled demand would be a permanent occurrence. When this wasn’t the case, Peloton’s losses skyrocketed, and its survival as a stand-alone company was in question.
The new CEO, Barry McCarthy, was brought in more than a year ago to right the ship. And he says Peloton is making substantial progress in its turnaround strategy, correcting the cost structure. For eight straight quarters, the business posted a net loss. However, the $335 million net loss in its most recent quarter (Q2 2023, ended Dec. 31, 2022) showed a decline on both a year-over-year and quarter-over-quarter basis.
McCarthy also wants to lean into the brand’s strength to drive higher demand. He believes partnerships with e-commerce juggernaut Amazon and specialty retailer Dick’s Sporting Goods can help Peloton’s visibility by expanding its reach to a wider customer base.
There are still major cracks in the business, though. In the latest fiscal quarter, connected-fitness subscribers increased 10% year over year, a healthy gain. But this segment lost money once again on a gross profit basis. Unless Peloton can actually sell these expensive exercise products at least for what it costs to make them, expect this to continue to be a drag on the financials. This problem is amplified by the fact that Peloton is still sitting on $791 million of inventory that it needs to work through.
Management sees revenue falling 27% (at the midpoint) for the fiscal 2023 third quarter, compared to the year-ago period. Macroeconomic uncertainty and softer near-term demand for its exercise equipment are concerns. The company does, however, expect the overall gross margin to be 39% thanks to very profitable subscription revenue continuing to overtake hardware sales.
A high-risk, high-reward play
Peloton shares hit an all-time high in January 2021, during the depths of the coronavirus pandemic when demand was surging and well before inflation and rising interest rates were spooking investors and crushing the valuations of growth tech stocks. But since that peak, the shares are down an eye-watering 94% and trade at a price-to-sales ratio of under 1.2. Based on the stock’s history, this is substantially below the historical average valuation.
Investors might be intrigued by the cheap valuation. However, there is still plenty of uncertainty surrounding this company. Moreover, investing in turnaround situations is incredibly difficult to do. It’s hard to predict whether a company can successfully execute its plans. Making matters worse in this case, Peloton is still unprofitable and faces an extremely uncertain economic backdrop in which to operate. That doesn’t give me too much confidence.
There might definitely be investors out there who are drawn to this situation, betting on a high-risk, high-reward stock. In my opinion, though, the downside risk outweighs the upside with Peloton at this moment. Sure, the business could be on its way to achieving profitability and registering the monster growth we saw a couple of years ago. But until it is firmly in that position on a consistent basis, I view the stock as uninvestable right now.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Neil Patel has positions in Amazon.com. The Motley Fool has positions in and recommends Amazon.com and Peloton Interactive. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
