Peloton (PTON -0.98%) stock is in a world of hurt in recent months. The beloved stay-at-home stock is coming unraveled as economies are reopening and folks have more options on where and how they can exercise. Shares are down 70% in the last three months.
The interactive exercise equipment maker initially cut the price of one of its popular products by $400 and is now reversing course and increasing prices. Let's look at why that might be good news for investors.
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Investing for expansion is backfiring for Peloton
Only a couple of quarters ago, Peloton announced it would be reducing the price of its Bikes by $400. The decrease was initially effective, as folks who were considering purchasing the $1,895 Bike got a much better value at $1,495. Sales simmered down after the initial boost, and the company was left with lower profit margins without higher sales. This was much worse than what management expected.
The company had made significant investments, including the $400 million acquisition of Precor, to increase production capacity. At the pandemic onset, Peloton's backlog of orders was so deep that customers were waiting for 10 weeks or more for delivery. In hindsight, management's decision to address the worsening customer experience was the wrong one. It turns out that the interest in Peloton's products was not as high as it appeared.
In addition to adjusting prices upward, Peloton announced it will be halting production of its Bikes and treadmills, another sign demand is tapering off. The price increases have not gone into effect just yet, and if management is already halting production because of lower demand, it is likely to get worse once price increases go into effect. Note, Peloton is not increasing prices on products directly. Instead, it is changing its former offer of free shipping to charge $250 starting Jan. 30.
Meanwhile, the investments in expansion have escalated costs at Peloton. In its most recent quarter ended Sept. 30, total operating expenses more than doubled to $622.4 million from $259.8 million in the same quarter the year before. Further, the total cost of revenue increased to $542.5 million from $429 million despite sales of connected fitness products decreasing in that time.
Management understands this is unsustainable and is taking steps to change its cost structure, including permanent reductions in its operating expenses.
Slowing growth may be just what the doctor ordered for Peloton
It seems Peloton's troubles began with investments in expansion. The surge in customer demand during the pandemic gave management the impression it could keep the momentum going even when economies reopen. Had management not spent on increasing capacity, a leveling off of sales would not be as harmful.
The higher expense base is draining cash from the company at an unsustainable rate. Peloton lost $561 million in cash from operations in its most recent quarter ended Sept. 30 and had $613 million in cash as of that date.
Raising prices could be good news for investors if it also follows through on other initiatives aimed at slowing the company's growth while improving profit margins and cash flow. It's easy to forget that Peloton was growing revenue over 100% per year even before the pandemic. It's when it tried to accelerate that growth that it got into trouble.
