Insights

2 Stocks to Avoid In a Recession

The U.S. economy has now logged two consecutive quarters of negative GDP growth. While economists may argue whether the U.S. is in a recession, it’s clear that consumers and companies are starting to pull back, at least in some areas.

Some companies are more recession-proof than others. Any company that sells something that people need while offering a strong value proposition can potentially do well even as the economy slumps. Companies that do neither are in trouble.

Connected fitness company Peloton Interactive (NASDAQ: PTON) and home goods online retailer Wayfair (NYSE: W) are both already suffering from slumping demand, and a recession isn’t going to be kind to either. Here’s why avoiding these two stocks may be a good idea.

Peloton Interactive

People flush with stimulus cash snapped up Peloton’s pricey exercise bikes during the early part of the pandemic. The company couldn’t keep up with demand, and the stock price soared into the stratosphere. Peloton was worth $45 billion in early 2021, a staggering valuation for a company that produced less than $2 billion of revenue in 2020.

Things have since changed. Sales have crashed, cost cutting is the order of the day, and the new CEO has a lot of work ahead of him to right the ship. Peloton had geared up to handle demand that simply didn’t materialize once people started getting back to their normal routines. Sales of Peloton’s equipment tumbled 42% in the fiscal third quarter, leading to an excess of inventory that’s putting a strain on the balance sheet.

Selling down that inventory will help the cash flow situation, but a recession isn’t going to make things easier. There’s certainly a market for luxury exercise equipment, but Peloton aspires to turn itself into a mass market brand. CEO Barry McCarthy has set a goal of eventually having 100 million paying subscribers on the platform. The company has already cut prices on its bikes, but even the $1,195 price tag on the low-end model is out of reach for many consumers.

There’s plenty of competition in the world of connected bikes, and some alternatives have mounts for iPads so that users can access whatever fitness content they want. If you buy a Peloton, you’re stuck with Peloton’s expensive $44 per month subscription. For comparison, Apple Fitness+ is just $9.99 per month.

Going into a recession, Peloton just doesn’t have a very strong value proposition. A turnaround looks like a long shot to me.

Wayfair

Shipping heavy furniture is expensive in normal times, but costs have ramped up further as inflation and supply chain issues wreak havoc on e-commerce companies like Wayfair. In a double whammy, Wayfair is also seeing demand implode as consumers tighten up their spending.

Wayfair’s revenue plunged 13.9% in the first quarter of 2022, the number of active customers cratered 23.4%, and the total number of orders delivered tumbled 29%. Much of what Wayfair sells is entirely discretionary — it’s easy for people to put off most purchases of furniture or home goods.

Wayfair’s gross margin dropped two percentage points to 26.8%, and operating expenses jumped 14% despite the steep revenue decline. The company managed to report positive net income and free cash flow in Q1 2021, but both metrics swung deep into the red this year. Wayfair posted a net loss of $319 million and a free cash flow loss of $331 million in the first quarter.

Wayfair has around $2 billion of cash and investments on its balance sheet, but it also has over $3 billion in debt, and it’s burning through that cash quickly. The company holds essentially no inventory, so it’s not exposed to the same inventory-related problems plaguing other retailers. But given the state of the economy today, it’s hard to see demand bouncing back anytime soon.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Peloton Interactive. The Motley Fool recommends Wayfair and recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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