Peloton earnings raised ‘more questions than there were answers’: Analyst

BMO Managing Director Simeon Siegel joins Yahoo Finance Live to discuss Peloton earnings and the company's cash burn problem as well as shed light on Gap's upcoming earnings and the outlook for Victoria's Secret.

Video Transcript

BRIAN SOZZI: All right. Bottom line, Peloton lost a ton of money in the most recent quarter, and they hinted more big losses ahead. Let's get right into it here with BMO Capital Markets Analyst Simeon Siegel. Simeon, you have been very right on this stock. So I'll put this to you, buy, sell, or hold after these results?

SIMEON SIEGEL: Hey, guys. Listen, we still have an underperform on the stock. I think that there were probably more questions than there were answers that just came out. And I think bottom line, you're watching churn grow, engagement slow, members slow. And that raises questions about the future demand.

- And so for the future demand, what product is it going to be in? Or are people just going to continue to opt for a digital subscription as their kind of standalone solution, even as Peloton and any connected fitness device company is going to be competing even more with an actual gym experience that Planet Fitness CEO has told us people are coming back to?

SIMEON SIEGEL: Yeah, it's an excellent question. Listen, let's-- I have the underperform on the stock. But let's give them all the credit that they are due. They created a fantastic community. They created a tremendous following.

And to be fair, the company is still worth around $4 billion at current prices. I think we are-- whatever the psychological term is. I'm not going to pretend to know it. But we're rooted or anchored to where they peaked. And we think, OK, this company went from $50 billion to $4. If we think about the fact, they went from 0 to 4, that's a totally different story.

That's a wild success. Most companies could not even hope for that. So I think as we think about this business, it's less-- maybe there aren't any future products. And I don't mean that facetiously. I mean, there will be a rower. But maybe the story of Peloton should simply be they have 3 million subscribers. Let's protect that subscriber base. Let's make sure we don't lose more members.

And from that perspective, if you can bear hug those brand loyalists, you have a pretty healthy, reliable, recurring business. The issue is the gross margin on the equipment was almost negative 100% this quarter. That's the equivalent of-- and, Brian, you and I talk about historically about the luxury companies burning their product. That's giving away the product.

So I think what we need to figure out is, does it make sense to try and find a new Peloton subscriber? If someone has not signed up yet, what gets them to sign up now? And that's why I think about the business. I know-- I know we generally think about the business as equipment versus subs.

I think it's more likely to think about them as existing versus new. Existing is great. New is not just dilutive. It's [INAUDIBLE].

- Well, surely, Simeon, them being available on Amazon will find them lots of new customers.

SIMEON SIEGEL: I just signed up for Prime yesterday to be able to get the bike.

- Yeah, right. [LAUGHS] And you get the bike for free, of course, right? Isn't that the deal? No. I mean, obviously I'm being facetious here. But the market reacted so positively to that news yesterday. And it was really puzzling.

SIMEON SIEGEL: Yeah, I think, listen, all jokes aside, I think that what the management team has been doing, what the new management team has been doing over the last month or so, I think, is very constructive. I think they are cutting the cash bleed. They're fixing the mistakes of the past.

And so what you should reply to me immediately is, well, Simeon, wasn't your-- like, didn't we fight for the last two years about all the retailers selling less, charging more being a good thing? And I think what we need to remember is-- and I'm sure we'll want to talk about Victoria's Secret. But I think if it's Victoria's Secret or Nike or any of these companies, once they sell less, they still have more people coming. You still wear through your sneakers and you need more.

Peloton has found its base. I don't think Peloton's issue is one of brand awareness. I think it's one of brand saturation. You go to Amazon for incremental distribution. You go to Amazon to increase your awareness. But it just-- we have to go back and say, every customer that already bought a Peloton is likely no longer a future equipment customer.

BRIAN SOZZI: Simeon, how much cash does Peloton raise this year? And where do they get it from?

SIMEON SIEGEL: Yeah, so that's an excellent question. And the reason I won't venture the answer is because I probably would have gotten it wrong this past quarter. I think we were all surprised at how quickly they were able to raise the last 750 last quarter.

So Peloton has been able to raise, over time, obviously, at incrementally worse rates-- a couple of years ago, they raised that convert at a zero coupon. Last year-- I mean, this past quarter, they now raised at more expensive terms. But I think-- I've had this conversation with a lot of investors lately about the free cash flow positive comment that they are trying to achieve.

And I think what we need to internalize is it would be very easy to get to free cash flow positive or at least break tomorrow if they just stopped making anything new. If they stopped-- if they turned off all sales and marketing expense, if they didn't make a single new product, and didn't worry about the logistics and the business immediately was just a subscriber base, there would obviously be shutdown costs. But free cash flow can get to positive or break even pretty quickly.

Free cash flow positive in and of itself should not be an aspiration. The question's, how you get there? Are you growing with free cash is another story. And I think that's what we're going to have to keep watching on the balance sheet because I think they could preserve their capital with relative ease. But then everyone has to internalize this is a $4 billion business that's not growing.

- Understood. Simeon, you mentioned a moment ago Victoria's Secret. Also know that you cover them and you track the stock, as well as their performance. When we think about a trade-down environment that consumers are wading through and continue to think about among themselves, how is a company like Victoria's Secret, perhaps, also going to be impacted by that if people decide, you know what? I'm just going to get my things from Target while I'm in the store or Walmart while I'm in the store versus going specifically to a Victoria's Secret store and getting items?

SIMEON SIEGEL: Yeah. It's an excellent question. And I know the rhetoric out there right now is high versus low income. I don't know that the data actually supports that. And I'm not suggesting that inflation isn't hurting the low income more than it's hurting high income.

But we're seeing companies-- I think it's more a function of product than it is of people right now, in that it's all about replenishment. And I think cereal and gas purchases need to happen. Replenishment is a week. So people have to go back, and they have to eat. And they have to commute.

I think, on the other hand, 3-wick candles or lingerie or sneakers or a Peloton bike or grills all takes a little bit longer. And so I think the question that I'm looking at-- I think the data we're seeing is that companies are actually segmenting their product performance more than they're in the data, and they're segmenting their income demographics in the narrative. And I think the data's going to be more powerful than the narrative.

And so what I mean by all of that is, listen, every company that sells apparel needs to figure out their catalyst, needs to figure out the replenishment because they're all sitting on a lot of inventory. And their choice is either going to be to try and promote to move it or to allow-- or to wait out their customer and maintain all the higher prices that they achieved through the past two years. Brands have been built.

The brand equity has been raised across the board. I think Victoria's Secret, like Bath & Body Works, like Under Armor, like a lot of others, will probably be better off recognizing that revenues probably need to come in a little bit. They probably need to normalize from that COVID hangover, which is not dissimilar to Peloton. But then people will come back. So my suggestion is promote less, even if it comes at the expense of revenues. And I think companies, like Victoria's Secret specifically, are still under earning.

- Simeon, I think I've asked you this question before. But I'm going to ask it again. Before the pandemic, consumers got habituated to discounts pretty much all the time, a very heavy promotional cadence, particularly from a Victoria's Secret or a Gap, for example.

Then that went away during the pandemic because the power was more in the hands of the retailers because people wanted the stuff. Where are we now? Are we back in a permanent discount cycle? Or do you think as we get normalization, these trends, we see people end up paying full price more regularly again?

SIMEON SIEGEL: It's pretty amazing, isn't it? We go to college. If we're unlucky or lucky enough to take an econ class and we learn about price elasticity of demand, and we learn that brands or retailers are-- like, we spend all this time. And at the end of the day, what we're finding is it actually is up to the brands.

It's up to the people that produce and the retailers. And what we found from 2008 until about last year or two years ago was that the consumers just kept getting more and more power. But it's not because consumers were more empowered. It's because retailers and brands were giving it to them.

It's because retailers and brands were fighting amongst themselves, choosing to chase with discounts with the need to get ever bigger. So what happened during COVID was they all realized that revenues are going to slow anyway. We may as well try to raise price because we're going to sell fewer units.

And you had this amazing awakening, where retailers realized, oh, wait, we've been in control the whole time. We just chose to lower price. I wish companies would take that message going forward. It does not look like they are.

So if the question is, will the consumer have discounts over holiday? I think, unfortunately for the retailers P&L the answer is yes. But I don't think it's because the consumers are all of a sudden more in charge again. I think it's because the retailers are falling back to this notion of demand is slowing versus last year. We need to try and jumpstart it. And the best way we to do that is with promotions, even if that comes at the expense of profit dollars. Forget about margins profit dollars.

That's why I think for those that have the ability, have the wherewithal, I think they can hold back and say, you know what? Maybe we just allow some of that COVID hangover to subside. And then we'll find our real base to grow up off of. We'll find our brand loyalists to double down on. That's a healthier business for everyone.

BRIAN SOZZI: Simeon, I'm reading in a July 11 note from you. It's when Gap pre-announced negatively. You said, "bottom line, low numbers are going lower as Gap continues to try to work through inventory in an environment that is turning increasingly deflationary." Gap reports today after the close. How much of a disaster-type quarter should investors expect?

SIMEON SIEGEL: God, I love your questions. [LAUGHS]

BRIAN SOZZI: No, I wait for you all the time to come on, Simeon. I just save all these great questions for you.

SIMEON SIEGEL: I just-- they're so imagery-full So listen, I think we-- a little bit after that report, we published a broader industry one that, Brian, you and I have spoken about called Red Means Go. And the premise was the expectation for retail is so low that all these companies should just cut numbers sufficiently, and stocks will go up.

That was in July. Last night, with the Victoria's Secret, I think our title was Red Means Go No Mo' and-- because I'm trying to achieve your level of poetic strength and failing.

[LAUGHTER]

But that notwithstanding, our premise was since we published that report, my group peaked up 20%. It's now up 10. So the idea of understanding low expectations, all you have to do is set them low enough, and the stocks will go up I think has been priced into the stock. Retail has had a great month or so. And now it's coming back to performance.

And so I think the reality is what Gap needs to figure out is who they want to be, same story. How big should they be? But I think a big question for Gap is breaking apart Old Navy, probably slipping around Old Navy versus Gap. I think the company believes Old Navy is their perpetual, let's just call it, piggy bank that will always grow.

And Gap is this business that they can just band-aid and figure out. And I think the reality is Old Navy's probably peaked. We've probably seen a ceiling to a very good business. Doesn't mean it's turning into a bad business. It just means figure out how big you should be.

And Gap is probably the one that they should be a little bit more creative and introspective on it. I don't mean creative in terms of big collaborations. I mean creative in terms of figuring out how to raise the profile of the entire brand.

- Well, Simeon, I have to say my one disappointment right now is that you're joining us via the phone because I'm told you shaved the beard. And I missed it last time, I guess, when you were on. So next time-- next time you got to be on camera.

BRIAN SOZZI: You get a little bit of everything here, there. Simeon, always good to see you. BMO Capital Markets Analyst, Simeon Siegel, have a great night with those Gap earnings.