Fitbit: Worth A Gamble At $5

After a lot of negativity surrounding the Q1 results of Fitbit (FIT), the stock interestingly held at $5. The fitness tracking maker is still important to watch from the point of reality and not for investors to get caught up in the momentum. A sector leader with a strong balance sheet provides a gamble worth taking as highlighted in previous research.

Source: Fitbit website

Watch For Momentum Swing

The market gets caught up on momentum on a regular basis. In the last quarter, revenues dipped by 17%, and despite maintaining full-year guidance, the stock took an initial hit. Seeing devices sold dip from 3.0 million to 2.2 million can be disconcerting to a long thesis.

Stepping back from the excitement of the quarterly results, investors can get a better view of the prospects. Fitbit has consistently held a theme of being worth the gamble around $5, but the stock really needs the revenue trend to reverse before shareholders will see any meaningful return.

FIT Revenue Estimates for Current Fiscal Year data by YCharts

The market won't reward a small company in a competitive sector until revenue momentum reverses. Despite maintaining full-year 2018 revenue guidance at $1.5 billion, analysts continue to reduce estimates below company forecasts.

The shift towards smartwatch revenues in the 2H isn't as set in stone for Fitbit due to bigger competitors in that category than their dominant category of fitness trackers. Market research firm Canalys estimates that Fitbit had an 11% market share of wearables in the quarter, but the company far trailed market leader Apple (AAPL) when it comes to actual smartwatches that are the revenue driver in the sector.

Better Operations

The sign of a good company is the ability to control what is possible and deal with the market environment as best as possible. Fitbit is working towards shifting the business towards more recurring revenues from subscriptions, but in the meantime, the operations provide an opportunity for drastic improvements.

The market valuation of Garmin (GRMN) at nearly $11.5 billion clearly points out the difference between how the market will value a slow growing business that generates lots of free cash flow and one with volatile revenues and consistent losses.

In the latest quarter, Fitbit produced a nearly similar gross profit on a $52 million decline in revenues. The 710 basis point improvement in gross margin is the type of operational improvement that will lead to predictable stock returns.

Source: Fitbit Q1'18 earnings release

With the worst quarter of the year out of the way, Fitbit will generate better results the rest of the year. The key though is figuring out how to turn the prospects of $1.5 billion annual revenues into profits to reward shareholders.

Garmin trails Fitbit in wearable sales, but the stock trades at a vastly higher EV/S multiple. Due to strong cash flows in other slow growing business units, the stock is worth nearly 10x more on only double the sales.

FIT EV to Revenues (Forward 1y) data by YCharts

Takeaway

The key investor takeaway is that Fitbit remains worth a gamble. The fitness tracker company still hasn't proven the ability to shift the momentum that will ultimately provide the catalyst for a higher stock price. The stock remains incredibly cheap, but the market will continue ignoring the value until revenue trends in a positive manner.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long 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: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.