Fitbit: Sell The Rally

| About: Fitbit, Inc. (FIT)

Summary

Q2 beat driven by low expectations.

Forward guidance not that impressive.

Company continues to sit on cash.

One of Thursday's biggest winners so far is Fitbit (FIT). Shares of the wearable device maker are up about 13% after the company's second quarter earnings report, basically bouncing off all-time public trading lows. While the headline numbers appeared strong, guidance was not as impressive, and the company continues to do nothing with its significant cash pile.

The company did beat on the top and bottom lines for Q2, although you have to remember that it did give weak guidance back at the Q1 report, so expectations were a bit low. Q2 revenues came in just $3 million above where analyst estimates were going into that Q1 report, and the stock is basically trading at similar levels.

Despite what appeared to be a good Q2 period, I was a bit disheartened by the company's forward guidance. The revenue midpoint for the Q3 forecast was a few million below street estimates. Additionally, while the company only lost 8 cents per share on a non-GAAP basis for Q2, as compared to its forecast for a loss of $0.14 to $0.17, management only raised the bottom end of the yearly forecast by 4 cents. Gross margin guidance was maintained, and stock-based compensation is expected to be less than previously thought, meaning the GAAP loss will still be fairly large.

One of my main criticisms of the company is that it continues to sit on a huge pile of cash, more than $675 million at the end of Q2, more than half of the company's entire market cap at this point. While I understand the smartwatch launch is coming later this year, the company has had this strong balance sheet for quite some time. It should be making other investments to grow the business, especially if it wants to compete with the likes of Apple (AAPL).

Fitbit's smartwatch dream could be dead on arrival if Apple has a major product launch this year that strengthens its Watch product. The fitness tracker market is also highly competitive, with basic pedometers going for less than $5 on sites like Amazon (AMZN). While Fitbit is clearly a leader here, the margins just aren't good enough currently to sustain long-term profits, especially once the company has to start increasing research and marketing efforts again.

While I understand that public markets are at all-time highs, that doesn't mean Fitbit can't acquire private companies, some of which may not have inflated valuations. If management doesn't want to go that route, it could at least use some of its cash for share repurchases. Even a $100 million buyback would instill confidence in this stock, as it would represent more than 7% of total shares at these prices.

While Fitbit reported a nice second quarter, the associated rally in shares puts the stock back in the sell range until the company does something meaningful. Even with revenues expected to rebound next year, the company is still projected to lose money on a non-GAAP basis, and GAAP numbers are even worse. With the smartwatch market already having a number of larger competitors, including Apple, Fitbit is entering a tough space. Until management decides to do something with its large cash balance, I think the stock could easily lose these gains.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in FIT over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.

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