The Next Multibagger Exercise Stock Might Surprise You

By Berna Barshay

Tuesday, June 9, 2020

Are virtual workouts a new paradigm for fitness or just the temporary ‘new normal’?

In yesterday’s Empire Financial Daily, I wrote about the rapid rise in virtual workouts and challenges to boutique fitness in the coronavirus era. Boutique studios will struggle, largely because they pack so many people, breathing heavily, into tight spaces. Gyms present some of the same public health challenges, but their larger size provides much better opportunities for social distancing.

Consumers know that gyms are by their nature a higher-risk environment for spreading disease. So it’s likely no surprise that in a late April poll, data-intelligence firm Morning Consult found only 12% of consumers were ready to go to a gym. A follow-up survey in late May saw that number expand to 18%.

But as gyms around the country reopen, many are establishing rigorous protocols to keep their customers safe. Some innovations include limiting capacity by taking reservations, removing half of machines from the floor, adding contactless check-in and temperature checks, increasing cleanings, and scrapping amenities such as water fountains and showers.

Despite the restrictions, there’s some good news…

According to a recent survey by broker Piper Sandler, the vast majority of patrons plan to keep their memberships… even if they don’t return right away. Eight-two percent of respondents said they were likely to retain their gym memberships even though only 47% plan to return to the gym within one month of reopening (84% plan to return within three months of opening).

But if digital fitness is the new paradigm and gyms are the old one, it’s possible that the new trend complements the old one rather than replaces it. For older or otherwise at-risk folks – and people who live with them – digital will be the right solution for months… if not years. For the young and healthy as well as those unencumbered with elder care, the benefits of a gym community will likely outweigh the small risks of going there.

Assuming that both digital fitness and traditional gyms can co-exist, it makes sense to look at the public company leader in each category…

Peloton (PTON) is on a roll…

In its most recent quarter, the company increased its revenues by 66%, grew paid subscribers by 64%, and reported a 12-month retention rate of 93% – impressive numbers, any way you cut them.

My initial take on Peloton was, “great product, bad stock”. History is littered with these… cool companies that come along with an innovative product, briefly trade at an exorbitant multiple, then come crashing back to earth. Wearable camera company GoPro (GPRO) would be the perfect example of “great product, bad stock”. The stock fetched more than $80 per share at one point in 2014 and had a sky-high valuation. Today, GPRO shares trade around $5.

I admit I have tons of trouble getting comfortable buying stocks with sky-high valuations, and Peloton definitely has one… It currently trades at 600 times earnings before interest, taxes, depreciation, and amortization (“EBITDA”) for its current fiscal year ending in June. I had to look at it on an enterprise value (“EV”)-to-EBITDA basis and not a multiple of earnings, because Peloton isn’t expected to make money in its current fiscal year… nor the following two. The company currently has a more than $13 billion market cap, which is a lot to pay for a business that’s three years away from making money.

Peloton also has negative operating margins despite making a healthy 45% gross margin on bikes and 58% gross margin on monthly subscriptions to its app. Peloton still loses money on an operating basis because of high selling, general, and administrative (SG&A) expenses. A bull would argue that selling and marketing costs will go down with size and ubiquity, and once Peloton has more customers to spread G&A expenses over, these costs will leverage as well.

But my Peloton skepticism has always been driven by putting a big multiple on one-time sales of bikes and treadmills. While the company’s app is a subscription business that should command a big multiple because it’s recurring and high-margin, equipment sales shouldn’t get a big multiple because they’re lower-margin and non-recurring. In its most recent quarter, Peloton still sourced 80% of its revenue from product sales.

Looking at the valuation of dominant subscription services like Netflix (NFLX), you’d expect the subscription part of Peloton to trade at 25 to 45 times EBITDA. Even if I give it the benefit of the doubt for being early in its life cycle and say the subscription business should trade 50 to 90 times its EBITDA (a big stretch), Peloton seems expensive on analyst estimates. Looking to the June 2021 year, the company still trades at 204 times EBITDA (and most of that EBITDA will come from selling products, not subscriptions).

This week, however, something happened that changed my perspective…

For more than 10 years, I’ve been a dedicated SoulCycler, and have taken almost 1,900 classes. Last week, I received a SoulCycle bike at home. I was super disappointed to see the company only has 65 classes available, versus literally thousands of classes at Peloton. And Peloton is adding classes at a much more rapid clip than SoulCycle.

After writing yesterday’s essay, I’m worried that SoulCycle will never be able to offer a robustly competitive library. If that happens, I could end up with the world’s most expensive clothes rack. I’m one of SoulCycle’s most loyal customers… but I’m probably going to return my SoulCycle bike and buy a Peloton instead.

And I’m not the only one. As the New York Times discussed last month…

If only SoulCycle had been able to get its highly anticipated exercise bike to market in time to meet the demand of its enthusiastic (bordering on obsessive) riders, who because of the coronavirus pandemic have been unable to go to any of the company’s 99 studios, closed since March.

Instead, many turned to Peloton, the at-home cycling company, for their fitness fix. Even the most “ride or die” SoulCycle goers who took hundreds of classes per year, paying $36 (sometimes $72 for a double) to bop up and down on a stationary bike in a dark, candlelit room while an instructor bellowed positive affirmations.

“SoulCycle is now late to the market,” said Winnie Clark, 33, an advertising creative director quarantining with her family in West Palm Beach, Fla. Last year, Ms. Clark spent more than $5,000 on SoulCycle classes.

She got hooked on her father’s $2,245 Peloton bike two months ago and now takes four on-demand classes per week. “I love the community Peloton has already built. I have a lot of friends on there,” Ms. Clark said. “I am a Peloton convert that may possibly go visit SoulCycle after.”

My personal experience tells me that Peloton has a strong moat. Its first-mover advantage is probably insurmountable, especially if its challengers are all facing financial distress.

Peloton equipment owners really use their bikes, which should be very encouraging for the bulls. Last quarter, during quarantine, average monthly workouts per subscriber hit a peak of 18, but even before that they were settling into the 10 to 14 range. Those bikes aren’t clothing racks!

So what about Peloton’s future potential?

The addressable market in the U.S. is probably the top 20% of households by income. If Peloton could eventually capture 20% of this market, it would have 4 million connected customers, versus its current 886,000. Margins would probably expand significantly… and at 4 million homes and a 30% EBITDA margin on subscriptions, Peloton would no longer be expensive.

Over time, the company can also expand its total addressable market by going international.

Peloton will likely own this market… and could be the Netflix of fitness.

But with PTON shares up over 65% this year, most investors are better off waiting to buy the stock. The eight weeks from mid-March to mid-May were literally the best environment Peloton could ever have, and the company probably pulled forward future demand and squeezed it into two quarters. Results for the June quarter should be impressive… but growth will probably slow down over future quarters.

And as this growth slows, PTON shares could pull in a bit. I don’t like buying after the “as good as it gets” quarter, which is a sentiment I expressed in Empire Financial Daily after Netflix’s first quarter.

But this former Peloton bear has turned into a bull. Long-term, risk tolerant investors might consider a small position in Peloton here and look to size up under $40.

My colleague Enrique Abeyta still loves Planet Fitness (PLNT) even 50% off the lows…

To get a perspective on the company, I turned to Enrique – he made the killer call on March 30 to add the stock in the portfolio in his new Empire Elite Growth newsletter. In just 10 weeks, subscribers who took his advice are up 48%. I was curious what attracted him to the stock, and as he explained in an e-mail…

When I originally recommended the stock, my thesis was simple – although every one of Planet Fitness’ gyms were shut down and the stock had almost been cut in half, the company had enough cash on the balance sheet that it could stay alive for almost two years.

My view was that eventually (and sooner than people thought), gyms would reopen and that pandemic-driven closures would have little effect on Planet Fitness’ customers. In fact, I thought the company could be a net beneficiary as weaker competitors went out of business.

I won’t be right about everything… but so far, I’ve been spot-on with this call.

I also asked for an update on where things stand today with Planet Fitness. As Enrique said…

The company has 800 of its 2,000 locations open… and more are opening up every day.

More important, average membership at these gyms has remained the same. This means that Planet Fitness has seen no drop off whatsoever in membership.

Given the low price point ($25 per month and less) for membership and the focus on the casual gym user, it was likely that Planet Fitness would be protected in the current environment. So far, this seems to be the case.

As weakness continues to ripple through the economy and with the potential for additional waves of virus outbreaks, I could see some weakness… but so far, so good.

In the meantime, multiple gym chains have gone bankrupt or hover on the precipice of bankruptcy, including Gold’s Gym (700 locations), 24 Hour Fitness (450) and Town Sports International (100). I think up to 2,000 gyms could go into distress.

With Planet Fitness sitting on a ton of cash, this will be market share it can acquire cheaply – either by buying outright locations or picking up customers that no longer have a gym to go to.

Of course, with the stock up so much, so fast, I wondered if it was too late for Empire Financial Daily readers. Enrique answered with a resounding “no”…

While PLNT shares have rallied nearly 50% since my recommendation, I still love this stock for both for the short and long term. Ultimately, this is a company that could likely deliver 3 to 5 times returns for investors with an investment horizon of several years.

If you’re still looking to take advantage of the incredible discount on Enrique’s Empire Elite Growth, it’s not too late…

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His approach is simple… He believes you don’t need a portfolio of dozens of stocks, or have to get involved with options, cryptocurrencies, or anything complicated. Enrique just focuses on the “best in class”… and tells readers exactly when to buy.

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Today in the mailbag, two more readers address the topic of travel refunds and one has feedback about Empire Financial Research dailies…

Do you own a Peloton bike or treadmill? If so, are you happy with the service? Any Planet Fitness members out there? Do you plan to keep your membership to Planet Fitness or any other gym? Share your thoughts at [email protected].

“Hi Berna, just got off the phone with Celebrity Cruise Lines.

“They are refusing to refund our deposit on a Greece cruise that was to leave from Rome in early September. Even though Delta has cancelled all flights to Europe, Celebrity is refusing to refund our deposit because their cruise has not been cancelled. Delta and American Express were great, but not Celebrity. Their stand is because the cruise has not yet been cancelled, no refunds are being issued.

“We have two choices: 1. If we don’t give them more money now we will forfeit our deposit. 2. We accept a voucher for a future cruise (with a time limit). If we take this option we forfeit the possibility of a refund even if Celebrity latter cancels the cruise.

“We scheduled this cruise well before anybody had even heard of this epidemic. I’m not sure I want to take a cruise in the near future, or ever again. Seems like we’re screwed either way.” – Dave Y.

“My wife & I own and operate a small boutique hotel in a remote ‘destination’ location (no serendipitous walk-in traffic, advance reservations req’d). Due to a plethora of complications and Catch-22’s we don’t qualify for any loans or bailouts – not complaining, just pointing it out. Our business income has obviously gone to zero, yet we gave full refunds to every cancelled reservation immediately upon request. (Which was 95%, a few gracious repeat guests have opted for open-ended rescheduling).

“Although we are among the least able to absorb the losses, integrity demands that refunds are the right thing to do. It really sucks that the wholesalers like Expedia, etc. bleed their suppliers on the front end, then turn the screws on their customers on the back end. Hopefully this virus crisis will have a silver lining of nudging the general public to ‘woke’ to the plight of small operators everywhere.

“By taking the small step of a Google search in order to contact the small business directly, not only will the business owners appreciate it, but it might help them survive so you can enjoy the non-corporate behemoth option in the future.” – Donn M.

“Fluor, Parsons, SAVE, BA, NIO, PK, CCL, NCLH, GE, LNG, APA, NBR. Next big one is LTM in South America the government will throw money behind them next month… where are you guys!” – Russell W.

Berna comment: I don’t think the government will or should offer bailouts to U.S. corporations that are domiciled outside the U.S. in order to avoid federal taxes. You can’t not pay in then take out. I think the voting public is with me on this, so the cruise lines won’t be rescued.

As for LTM, it’s a Chilean company, so the U.S. won’t be coming to the rescue… that’s up to Chile, and I don’t know enough about Chilean public policy and its financial situation to comment.

As for the airlines, Boeing (BA), Nio (NIO), and natural gas companies… none of those have been an area of focus for me. It’s a big market – no one can cover everything, especially in a free e-letter. Keep an eye on my colleague Whitney Tilson’s daily e-mail for thoughts on the airlines, as he has been much more focused on that area of the market.


Berna Barshay
June 9, 2020

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to more than $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

Click here for the full bio.