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The Ratings Game: Peloton stock rallies after analyst says company isn’t getting enough credit

Facing low expectations, Peloton Interactive Inc. shares have ample room to ride higher, according to an analyst.

Bernstein’s Aneesha Sherman initiated coverage of Peloton’s stock

with an outperform rating and $40 price target late Monday, arguing that investors are far too pessimistic about the connected-fitness company’s prospects.

Shares of Peloton are up more than 9% in midday trading Tuesday. Shares have declined 80% over the past 12 months as the S&P 500

has increased about 7%.

Sherman noted that “the stock’s catastrophic fall from grace has been accompanied by rapid downward sales and EPS [earnings-per-share] revisions, to the point where we think the worst-case scenarios are already priced in.”

The company has struggled in recent months to adapt to new behavioral trends as the pandemic evolves. While Peloton had been a big winner in the early days of the COVID-19 crisis as people sought interactive fitness experiences within their homes, Peloton has seen new demand fall off now that pandemic-related restrictions have eased.

Two years of COVID-19: How the pandemic changed the way we shop, work, invest and get medical care

Sherman expects that the company will be able to regain its mojo, and she sees the main question as simply “when.”

“Investors will disagree on how quickly one should assume Peloton will get back on track” while turning free-cash-flow positive, and margin positive, she wrote. “Regardless of the pace of the ramp, we believe the direction of travel from here is up and to the right.”

Sherman deems Peloton’s business healthy, even though the company miscalculated demand trends and didn’t appropriately manage its supply chain.

“We think the engaged user base, sticky subs revenue streams, and growing TAM [total addressable market] are markers of a healthy underlying business that are hard to recreate,” she wrote. “With these fundamentals, better management around key decisions such as supply chain, store growth and pricing can drive real upside.”

See also: A bunch of fitness companies have jumped into the IPO market this year. It’s not working out.

Sherman noted that even in the pre-pandemic days, Peloton enjoyed “a cult following of die-hard engaged (some might say obsessed) users.” The company continues to generate strong engagement from existing users and has a low churn rate, she said.

Peloton has opportunities to expand its connected-fitness offerings further with forays into different areas of the exercise world, Sherman continued, and that could help give the company a much larger total addressable market than it previously estimated.

Sherman acknowledged that a key issue for Wall Street concerns Peloton’s bottom line, but she’s upbeat about several trends in the business, including an eventual mix shift toward higher-margin hardware and a new delivery fee.

“A big part of Peloton’s restructuring plan involves establishing a clear path to consistent profitability and sustainable FCF [free-cash flow],” she wrote. “With an increasingly variable cost structure on supply chain, we think PTON can protect the downside.”

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