Why Fitbit Stock Isn’t Interesting Anywhere Above $5

Shares of Fitbit (NYSE:FIT) started 2019 out with a bang on optimism regarding Versa smartwatch sales during the holiday season. Fitbit stock rallied from a sub-$5 low in late 2018, to nearly $7 by mid-February.

But, around that time, I warned that the rally in Fitbit stock was on its last legs, and that the “next big move in the stock will likely be lower.” Fast forward three weeks. The next big move in Fitbit stock has happened, and it was a big move lower.

Fitbit reported disappointing holiday quarter numbers in late February that included flat revenue growth, tepid device growth, continued gross margin erosion, and a weak guide which implied that the big turnaround everyone was hoping for, will progress a lot more slowly than expected. Fitbit dropped big in response. It now trades under $6, or about 15% off its pre-earnings highs.

Unfortunately, this drop is only the beginning. The company’s fourth quarter numbers and guide illustrate a dour reality for Fitbit. Simply, the wearables market has largely moved on without it and growth going forward will be tepid at best.

When it was up at $7, Fitbit stock was priced for big growth. Down at $6, the stock isn’t priced for big growth anymore. But, it still isn’t priced for tepid growth, either.

Instead, tepid growth isn’t appropriately priced in until around a $5 price tag. Thus, until Fitbit stock drops to $5, it’s best to stay on the sidelines.

The Numbers Aren’t Good

There were murmurs that a Versa smartwatch boom was going to drive really strong holiday numbers, which would pave the path for a potential 2019 turnaround through a strategic smartwatch pivot.

None of that is happening. Instead, revenue growth was flat in the fourth quarter, with all growth coming from the still nascent Asia-Pacific market (all other developed markets saw revenues drop year-over-year). Device sold growth was 3%. Average selling prices dropped 2%. Gross margins took a big hit thanks to the smartwatch shift.

In other words, even during what was supposed to a blockbuster turnaround quarter for Fitbit thanks to its best product yet, the company still barely grew.

The guide implied things won’t get better any time soon. Device sold growth is expected to be only mildly positive in 2019, while ASPs are expected to keep dropping. Revenue growth is expected in the low single digit range. Gross margins are guided to keep falling. Operating leverage will continue, but at a lesser rate.

Overall, the takeaway is clear: the big Fitbit turnaround isn’t coming. Instead, there is a mini-Fitbit turnaround happening right now. But, that turnaround is characterized by low single digit top line growth and continued gross margin pressures.

There are plenty of reasons behind this tepid turnaround, most of which have to do with the fact that the wearables market has simply fallen in love with other products, and Fitbit’s share in this market is becoming increasingly niche. Nonetheless, the numbers don’t lie, and the numbers imply that growth will be largely unimpressive going forward.

The Valuation Still Has Room to Fall

Fitbit still isn’t priced appropriately considering its tepid long term growth prospects.

The math here is simple. We are talking about a $1.5 billion revenue company that is projected to grow at a low single digit rate over the next several years. At best, that puts revenues around $1.8 to $1.9 billion by 2025. Gross margins are getting hit by the smartwatch pivot, but have potential to stabilize around 40%. Assuming opex dollars continue to drop towards $600 million by 2025, that would equate to a 32-33% opex rate.

Putting all that together, a realistic best case scenario for Fitbit is $1.85 billion in revenues by 2025 on high single digit operating margins. Reasonably speaking, that could flow into around $0.40 in EPS by 2025.

Based on competitor Garmin’s (NYSE:GRMN) average forward P/E multiple of 18, that equates to a 2024 price target for Fitbit stock of just over $7. Discounted back by 10% per year, that equates to a fiscal 2019 price target of just under $5.

As such, Fitbit stock isn’t worth considering in 2019 until it drops below $5.

Bottom Line on FIT Stock

Fitbit stock yet again hit a wall called reality in late February, and the stock is feeling the aftershocks of that head-on collision. These aftershocks will stick around because the valuation is still too big considering the company’s long term growth prospects. A drop to $5 within the next few months seems likely.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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