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Why Nautilus’ blowout quarter could be good news for Peloton

On Tuesday, Rosenblatt analyst Bernie McTernan reiterated his buy rating on shares of Peloton, following strong Q2 results from rival Nautilus as “home fitness trends remain strong.” Despite the fact that supply constraints will continue to be the limiting factor on Peloton’s growth, Rosenblatt still considers it to be the leader in home fitness. McTernan joins The Final Round to talk about his bullish call.

Video Transcript

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MYLES UDLAND: All right, welcome back to "The Final Round" here on Yahoo Finance. Myles Udland with you in New York. It is time now for our Call of the Day. Today we're talking about Rosenblatt's latest note on shares of Peloton, the firm reiterating a buy rating and a $70 price target on the stock, following results out of Nautilus, company that owns Bowflex, among other fitness brands.

And Rosenblatt analyst Bernie McTernan joins us now to discuss this call. So, Bernie, let's start, I guess, with the overall thesis here that you see from Peloton-- and I guess the strength of the at-home fitness trade obviously has had a huge run during this period. But do you feel like this is resetting the possibilities for the entire space, even in a way that surprised you as an analyst and perhaps even Peloton as a company?

BERNIE MCTERNAN: Yeah, that's exactly it. So really, there was a shift to home fitness going on before the coronavirus, and coronavirus has really just accelerated these trends. And we think the home fitness market is gonna be huge in the US. There's about 65 million gym members in the four territories that Peloton covers and only about one million connected fitness subscribers. So there's still a lot of runway for growth here.

And just on the Nautilus numbers from last night, revenue's up 94% year over year. That compares to 11% in the March quarter. And consensus was only expecting 16% growth.

So those trends are certainly encouraging for Peloton for the upcoming quarter. But the company also spoke about how the TAM is expanding. And they did some research that showed 10% to 25% of gym-goers say that they're not gonna go back ever again. And then they also were talking about at-home fitness as a complement for gym members and why that's interesting for Peloton in particular.

Right now, you're thinking about Peloton, an expensive product-- $2,300 bike. Well, going forward, there's gonna be a focus on affordability. And I think that'll allow them to play in that complement mode more.

DAN ROBERTS: Bernie, Dan Roberts here. As you guys note in your note, Nautilus management cautioned that these great results were maybe temporary because of the current environment. And that reminded me, back toward the beginning of the pandemic, when Peloton really took off and was one of these, you know, stay-at-home names along with Zoom, there were some notes-- maybe it was one of yours, maybe was a different analyst's note we discussed-- that cautioned that maybe there's a concern of a pull forward in demand for Peloton, and that even though things are high flying right now, maybe it's almost, ironically, a negative, because if everyone's buying up the bikes now, well, a year from now, if things are back to normal, so to speak, and we emerge from the pandemic, then maybe Peloton cools. Is that still a concern for you with this market, that maybe all of this is just due to staying at home, and even though it does seem like a lot of people will be working from home for a while, there are also companies that, when the coast is clear, are gonna make people come back to the office?

BERNIE MCTERNAN: Yeah, I think that definitely plays a point. But why we're so bullish on Peloton is really that it's a best-in-class service. So it's a much cheaper option, too, than doing a SoulCycle, which might be $40 for a class. With Peloton, it's $40 for a month for the connected fitness subscription.

So we really think the product quality is what sets them apart. And then, you also have other companies saying that this is valuable as well, like Lululemon buying Mirror. So we think this is still early days in the home streaming market. Things are accelerating because of the coronavirus, but we think there's certainly growth to go on top of these levels.

- Bernie, adding to Dan's point there, how much of a pullback should be priced in? I mean, obviously there's no vaccine right now. A lot of people aren't gonna be going to the gyms. But when they do reopen, when you talk about the complementary model, what does that look like?

BERNIE MCTERNAN: Yeah, so the thing about Peloton, as I mentioned before, with such a high quality service, their churn is pretty much astronomically low, like, lower than some wireless carriers. So you're talking sub-1% monthly churn. So that's why I think this next leg of the story is gonna be focused on affordability. And what that means is that someone might buy a thousand-dollar bike, and then you're paying a $40 dollar monthly subscription for a really long time. And that's really one of the things that's interesting about this stock is that you have the product sales, but then you have the subscription business as well.

So Nautilus trades at about one times revenue. The reason why Peloton trades at, you know, five, six times revenue is because you have that subscription piece. So every product sale that happens-- that's just adding to that mix shift of revenue from product sales towards subscription. And the subscription business has a 70% gross margin, so over time, the business should be tracking in that way.

- Bernie, this is Emily. One of the things I thought was interesting about your note was just the framing of using Nautilus's success as a potential positive for Peloton. And as we see this whole industry become more saturated, do you see this as a winner-take-all, a winner-take-most, because, after all, there is only so much room for people to have fitness equipment in their homes or apartments?

BERNIE MCTERNAN: Certainly, and there are-- there's certainly a lot of competition out there, not only Nautilus but, you know, Echelons and other low-cost provider-- Mirror, Tonal, all the apps you can get in the App Store. So it certainly is a crowded field, but we think ultimately with Peloton's product quality, it just creates a positive flywheel effect where you get more members on the platform.

That allows you to pay the best instructors possible. That's more classes that's in your library in addition to the live classes. So they just have such a massive head start that we think they're gonna-- they're a leader now in at-home streaming fitness. And we think it's gonna continue to be that way for the time to come.

MYLES UDLAND: And then in terms of other products that Peloton might roll out, I mean, I had always said, like, you know, the best fantasy M&A would just be Peloton, I guess, buys Equinox, and they rebrand all the gyms as Peloton Gyms or something. But that would seem to be terrible now, because no one wants to be in a physical gym. What do you see on the product side for Peloton? How important is that for them, I guess, longer term?

BERNIE MCTERNAN: Right. And don't forget, too, that Equinox owns SoulCycle. So they're-- SoulCycle's also getting into the at-home fitness market as well with selling bikes.

So in terms of next products, I really think the focus is on affordability. So that's getting a thousand-dollar bike, maybe a $2,000 treadmill. There's been talks about maybe rowers and maybe ellipticals, but really, there's, I believe, three million bikes that are sold each year in territories and about five million treadmills. So this is a massive market opportunity where people are constantly buying new products and spending money on gym memberships where Peloton's still very early innings and taking share.

DAN ROBERTS: Yeah, Bernie, Dan again here. And just for fun, because the idea of when people might return to gyms is a pet topic on this show-- and Myles Udland just said he misses going into the gym-- but I guess I'm doing it wrong, because instead of buying a Peloton bike, we've just bought a boxing bag for our home, which I'm very excited about. But I do wonder, I mean, I remember right before the pandemic, certain types of classes were exploding in popularity. We were talking about the rise of boxing gyms as the hottest new form of fitness. Do you guys believe that the rise of Peloton and these stay-at-home bike services will actually be a negative for in-person gyms and those boutique fitness classes that were so hot before the pandemic?

BERNIE MCTERNAN: Absolutely, and from the studios that we speak to, everyone needs a streaming option right now. So we recently did a call with Jetsweat, and they're trying to be like the Shopify of fitness, where providing like a turnkey solution for gyms to really get online and get into streaming. Just personally, so I'm doing the $12.99 Peloton Digital. So that's yoga, that's outdoor running, that's body weight strength classes, so you know I'm doing-- you know, I know-- [LAUGHS] I really enjoy the experience, and I think they're doing a great job.

MYLES UDLAND: All right, Akiko, you have a friend now-- you and Bernie, both doing the streaming [INAUDIBLE].

- Yes. I am about the non-bike Peloton service, which I have picked up for the last few months.

BERNIE MCTERNAN: I did the 90-day free trial and just kept it going.

MYLES UDLAND: There you go. I was [INAUDIBLE]--

- Same here.

BERNIE MCTERNAN: They've got over a million people who signed up for the 90-day free trial, so we'll learn September 10, which is when their earnings is, how many of those converted to paid subscribers or not on the [INAUDIBLE].

MYLES UDLAND: Just a sentiment check, too-- it was only a few years ago everything was the Uber of x. And Bernie, that's first time I've heard of Shopify of x. [INAUDIBLE].

BERNIE MCTERNAN: Yeah, exactly. There you go.

MYLES UDLAND: Tells you where things are going, you know, want to frame yourself as the Shopify of this new thing. And so a sign of the times, I guess.

All right, Bernie McTernan, analyst with Rosenblatt. Again, the call reiterating a buy, $70 price target on shares of Peloton. Bernie, thanks so much for joining the program.

BERNIE MCTERNAN: Thanks for having me.