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Peloton's (PTON) lackluster earnings on Tuesday were a disappointment for investors.
Third-quarter revenue came in at $964.3 million, missing consensus estimates compiled by Bloomberg of $971.6 million — marking the company's first year-over-year decline in sales since the company went public in 2019.
According to one analyst, hardware is a key issue for the company.
"I think it's about cash flow buffer in an environment where supply chain logistics and storage of these bikes is getting more and more expensive," Bernstein Analyst Aneesha Sherman said on Yahoo Finance Live (video above). "And that cost is unpredictable. So I think it's back to the hardware."
At the height of COVID, Peloton saw huge success with its business model as millions of Americans were staying at home and interested in using exercise machines to get in shape. However, as in-person work returned and the number of coronavirus cases went down, Peloton found itself with excess supply and not enough demand.
"This quarter was all about the problems with hardware," Sherman said. "Hardware sales were half of what they were a year ago, and hardware inventory is double what it was a year ago. So there's just too much hardware sitting in warehouses that isn't selling, and it stems from the oversupply and the over-ordering over the course of the pandemic. This is the big challenge."
'A whirlpool of micro and macro issues'
In a high inflationary environment, any excess spending by a company could become extremely detrimental to its bottom line. This is also the case with Peloton, analysts argue.
"When you have a bunch of unused hardware that's sitting in warehouses, that's difficult and expensive to store," Sherman said. "Storage and freight costs are unpredictable. You need enough of a cash buffer to get through until you're able to unwind that inventory and then benefit from cash flow. So again, it's waiting those couple of quarters before the hardware can sell through before they can end up with a much leaner inventory position. It's right now 20% of sales."
Rohit Kulkarni, a senior analyst at MKM Partners, noted that the company is still in the "very early days of transition."
"They are trying a lot of new things," he said on Yahoo Finance Live recently. "They are cutting prices. They are increasing prices on the subscriptions. They are testing bundling offers. ... A lot of moving parts while they are trying to control their cost structure."
Though the company is currently strapped for cash, Kulkarni said the company could consider relying on third-party sellers to reduce their capital expenditure. He also stressed that this transition of Peloton remains a "show-me story."
Until the company can show signs of a turnaround, he said, it remains in the "penalty box."
"This company has caught itself into a whirlpool of micro and macro issues," Kulkarni said. "We expect this transition to be painful and long."
According to Sherman, the company needs a few more quarters of transitioning to fix its inventory issue and return to a positive free cash flow position.
"I guess the question is now: In an environment of growth, in an environment of excess inventory, with rates going up, with spending potentially coming down across the sector, is this going to be tolerated by investors?" Sherman said. "I think that's the big question related to the stock. On a 12-month basis, I'm still positive on the trajectory. We should see sequential improvement through the year as that hardware inventory base starts being wound down. But I think the question is: To what extent are investors going to be able to wait that out rather than look for opportunities in the short term?"
The bull case for Peloton
Not everyone is bearish on the future of Peloton, though.
Ron Josey, a senior analyst at Citi, said he knew going into Peloton's earnings call that the company would report a "messy" first quarter but still saw bright spots in the results.
"The first, most important thing for us is on the subscriber side," he said on Yahoo Finance Live recently. "So it's knowing that they're adding subscribers, that engagement is improving. I think on average, what the average member works out with Peloton about 19 times a month. And so from a product market fit perspective, it seems like they have everything."
Josey stated that going forward, his focus would continue on the subscriber base, along with addressing the supply issue.
In his shareholder letter, Peloton CEO Barry McCarthy stressed that the excess supply was "primarily a cash flow timing issue, not a structural issue" and said the obsolescence risk was "negligible."
The company finished the quarter "thinly capitalized" with $879 million in cash, according to McCarthy, down from over $1.1 billion a year ago.
Adding to the issue was the steep reduction in consumer demand, which led the company to start slashing prices last month. McCarthy said this led to the company consuming "an enormous amount of cash, more than we expected."
Still, analysts like Josey are remaining bullish.
"Frankly, what Peloton is doing overall in terms of innovating ... it connected the fitness market and [merged] both the bike or the hardware with the experience," he said. "And so in our view, there's a lot of value to what Peloton is doing."
Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter: @daniromerotv