Is Peloton's AI Pivot a Buy Signal?

Peloton Interactive (NASDAQ: PTON) has given investors a roller-coaster ride over the last five years. Shares soared to a high of $171 in 2021, but as people returned to the gym, the stock plunged and is now trading around $4 with a market capitalization of $1.7 billion.

Revenue growth has stalled, but Peloton still has more than 2.6 million subscribers. That base generates recurring revenue and cash flow, which helps explain why the stock looks cheap, trading at about 5 times trailing-12-month free cash flow.

Now, management is leaning into an artificial intelligence (AI)-focused strategy to make the product more personalized and capture a slice of the $7 trillion global wellness market. Early results look encouraging, but is it enough to make the stock a buy today?

Image source: Peloton Interactive.

Improving financials

CEO Peter Stern said on the recent earnings call that Peloton wants to use AI to help members beyond workouts, including "an array of fitness and wellness domains." He didn't share specific product plans, but the opportunity could significantly expand Peloton's addressable market. The wellness market spans everything from supplements and nutrition to weight loss products.

If Peloton can extend its AI-driven coaching into those areas, it could deliver personalized recommendations based on each member's unique fitness journey and potentially create new ways to monetize its membership base. This could be a powerful growth engine.

In the most recent quarter, connected fitness equipment (bikes, treadmills, and more) made up 37% of the company's $657 million in total revenue. But the hardware business is not the profit engine, as it sells equipment at only a small markup over cost. The real moneymaker is subscriptions, which accounted for 63% of revenue.

On that front, the company's AI coaching feature is resonating, with 46% of active users engaging with personalized guidance. Subscriber churn rose from 1.4% a year ago to 1.9% last quarter, which are strong numbers for any subscription service, especially given Peloton's recent subscription price increases.

Meanwhile, profitability continues to improve. Gross margin climbed a few percentage points to more than 50% last quarter, with adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) surging 39% year over year to $81 million. Peloton also reduced net debt by 52%, raised full-year margin guidance, and expects to generate at least $275 million in free cash flow.

Altogether, the AI pivot and the improving financial profile are encouraging signs, but there are a few reasons I would remain cautious on buying the stock.

Peloton still has work to do

First, total revenue is still down, falling 3% year over year last quarter, and management expects full-year revenue to decline by 3%. Investors should want to see growth, especially in the subscriber count, which also declined.

Second, the fitness and wellness markets are highly competitive. Peloton's weak revenue growth over the last year is a symptom of a crowded market with plenty of alternative products.

Peloton's financials are moving in the right direction. However, with revenue still soft amid a competitive market, investors should wait to see evidence that the company's AI features can expand membership and reignite revenue growth before buying shares.

John Ballard 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.