Fitbit: Bullish But Not Buying Yet

Summary

• Fitbit's management had provided dismal guidance for Q1, as such there was not much to expect.
• The worse part of Q1 results was the guidance, which calls for continued losses for the rest of the calendar year.
• While there are several things to be bullish about, they are not enough to make a buyer of Fitbit shares yet.

Fitbit's (NYSE:FIT) Q1'18 results were in line with guidance provided the previous quarter. And, because guidance was already very dismal, there was not much to expect for Q1.

FIT had provided revenue guidance in the range between $240 million and $255 million, and the quarter came in at $248 million. The company's non-GAAP EPS guidance was a loss in the range of $0.21 to $0.18, and the actual number came in at a loss of $0.17. The results were better than the consensus by $0.02 EPS, and revenue by $0.65 million (yawn).

Q2 guidance was not any better. The company is expecting revenue to decline 19% Y/Y, in the range of $275 million to $295 million, with a non-GAAP loss in the range of $0.27 to $0.23 per share.

Finally, full-year guidance calls for lower margins, breakeven free cash flow (at best), stock-based compensation expense of approximately $110 million, and revenue of about $1.5B vs. $1.6B last year. So, is there any reason to be a buyer of FIT in 2018? Probably not.

Fitbit's problem

Something that I have come to realize lately is that FIT has a core-product disadvantage. By this, I mean it does not have a "bread and butter" product like the iPhone, which sells quarter after quarter.

The company literally has to reinvent itself every quarter and come up with a new line of products. This is because whatever it came up with several quarters ago is out of fashion or outdated.

And, the problem that arises is that it can never gain permanent revenue traction with any product. At least, this has been the case so far. However, with the introduction of the Ionic and Versa line of smartwatches, this might change in the future.

The company has repeatedly said it expects its device mix to continue to shift towards smartwatches over the course of the year. As per the Q1 conference call, smartwatches constituted approximately 30% of revenue, doubling on a sequential basis in percentage terms. This is a very bullish sign in my book. I would be extremely bullish on FIT shares if smartwatch revenue reached 60% or more.

Why? Because, by having a bread and butter product, the company can concentrate on other things, instead of having to reinvent itself over and over.

Smartwatches will be FIT's main wearable revenue driver in the near future, but will also be the driver for service revenue. Be it Fitbit Health Solutions, personalized care, or coaching software, the key to service revenue will be centered around the smartwatch.

Granted revenue is still immaterial when compared to FIT's wearables business today, however, I have very high hopes that over the next 12 months or so, services will be a sizable business. This is because everything FIT does from now on is connected to the Ionic and Versa.

The company expects smartwatch revenue to surpass tracker revenue in the second half of 2018. This might mean that, by the end of the year, the lion's share of FIT's revenue will be smartwatches. This is a good thing, because it might mean service revenue might also take off in 2019.

Several days ago, the company announced a collaboration with Google (GOOG) (GOOGL) for the development of consumer and enterprise health solutions. As part of the agreement, the company will migrate over to Google's new Healthcare API. Mind you, this will also integrate FIT medical solutions into the healthcare system.

So, overall, while the current results were not satisfactory, the company is proceeding with a very well organized plan, with the smartwatch at the center of attention.

As for the balance sheet, it continues to remain spotless. The company continues to have no debt, with about $700 million in working capital available.

So is Fitbit a buy?

This is a very difficult verdict. On the one hand, we know that revenue will be lower on a Y/Y basis, so there is no catalyst to buy shares at the current time.

On the other hand, the company has a clear revenue roadmap ahead, with the smartwatch as its centerpiece. I foresee services will kick in at some point down the road, and they will be substantial. We just don't know when this will happen. In addition, I am sure something good will come out of the collaboration with Google.

From a valuation perspective, all the above information is baked in the stock already. At current levels, FIT is trading at a very depressed market cap. The current market cap is about $1.2B, with the stock trading at about 0.75X revenue. As such, I think there is a high margin of safety in FIT shares, even if revenue is forecasted to be lower by about 8% this year.

When a balance sheet is not deteriorating sometimes, I am willing to sit on a stock at depressed levels, even if I do not foresee growth over the short term. This, assuming I am also modeling revenue growth and profitability down the road.

So, what investors have to take into consideration is that, on the one hand, current levels offer a good entry point, but they might not see capital appreciation for a while.

Bottom line

FIT is a turnaround situation play in progress. Currently, FIT shares are trading at depressed levels, but, at the same time, I think the company will see much better days in 2-3 quarters.

It's very difficult to make a call if one should buy the stock just yet. But if you do decide to sit on the stock at current time, I think downside is limited.

Personally, I like the company a lot, but I will refrain from buying at the current time, mainly because I am involved with other stocks at the moment. I would, however, be a buyer if the stock falls around the $4 handle.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.