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Motley Fool Issues Rare “All In” Buy Alert

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It's the sweat that investors are starting to regret. Shares of Peloton Interactive (PTON -3.63% ) plummeted 18% on Thursday following another disappointing quarterly report. The stock has now fallen 94% -- yes, 94% -- since peaking early last year. 

There wasn't a lot to like in the report, but there were slivers of a silver lining. Peloton's negative free cash flow improved from the pace it was averaging in the two previous quarters. The shift to an asset-light model finds the spiraling premium fitness specialist forecasting break-even cash flow by the second half of the new fiscal year. 

The bad obviously outweighs the good judging by the market's reaction to the fresh financials. Let's look at the reasons you may want to sell Peloton here, but let's also end on a positive note by exploring the one reason why you might want to buy. 

The first reason to sell is that the metrics that measure success are going the wrong way. After back-to-back quarters of single-digit-percentage top-line growth to kick off fiscal 2022, investors were stunned three months ago to see a 24% year-over-year decline in revenue for the fiscal third quarter. Thursday's report revealed a 28% slide.

It gets worse. If we turn to sequential trends for a little more granularity, we see that Peloton's membership base contracted slightly to 6.9 million. Peloton subscribers are also less engaged, with the number of workouts per member down 21% since the fiscal third quarter. This isn't a matter of seasonality and folks enjoying the outdoors over the summer. That same metric is down 26% from where it was a year ago. Churn rates have nearly doubled. 

The second reason to sell is that it's hard for a luxury brand to get back on track after it stumbles. A lot of bad things happened in the 2021 calendar year to tarnish Peloton's brand. Last year started with a treadmill recall after some tragic accidents involving young children and pets, ending with a Peloton stationary bike workout being used as the catalyst for a key character's death on a popular TV show. Peloton was still posting sequential growth at the time, but it was clearly slowing. We're going the wrong way now, and high-end brands are hard to turn around when they're starting to fade.

The third reason to sell is that all of the cost-cutting measures that Peloton is hoping investors will cheer could be detrimental to the perception of the brand. Peloton's new executive leadership is migrating to an asset-light business model. It is now outsourcing the production of its connected fitness hardware after closing down its owned manufacturing activities in Taiwan. Peloton is shifting half of its member support team to cheaper third-party providers. It's also moving away from managing the home delivery of its treadmills and bikes, letting someone else tackle the last-mile logistics. These are all smart moves on paper, transforming fixed overhead into variable costs. However, this is a premium brand. You may or may not realize that someone outside of Peloton is now building and delivering your gear or handling your support call, but it certainly takes the shine from what consumers expect out of a relationship with a premium luxury product.

The best reason to buy right now could be the ugly stock chart. Yes, Peloton is down 94% from the peak it hit 19 months ago when we thought in-home fitness would be the new normal. Is this really just 6% of the company it used to be? I get it. That last point is deceptive because Peloton's debt has ballooned over the past two years. The slide in enterprise value isn't as bad as what shareholders have been through. Is Peloton really going on a road to zero?

Peloton expects to stop generating negative free cash flow in just a couple of months. A lot of people that bought Peloton bikes and treadmills at the onset of the pandemic aren't going to abandon their four-figure investments. There will continue to be a large enough base of connected fitness subscribers to either give Peloton time to turn things around or attract a buyer. Shouldn't buyout speculation provide a floor to the stock at this point?

With gym stocks bouncing back as the economy reopens, as well as our ongoing desire to look and feel better, should we really treat Peloton like the 2020 sourdough starter you've seen abandoned? Peloton can afford a near-term contraction in members if it's able to continue improving its cost structure. The company has time to get it right, but unlike its stationary bikes, it needs to make sure that all of this pedaling will ultimately get it somewhere.

Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Peloton Interactive. The Motley Fool has a disclosure policy.

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