Fitbit (FIT, Financial) has performed nicely since it reported better-than-expected earnings last month. Although shares have rallied on the back of strong earnings, this is not a turnaround and Fitbit will probably head lower in the long-term.
Fitbit Needs to Spend Heavily
Fitbit was one of the most volatile stocks in 2015 as it lost a giant portion of its value due to fears of surging rivalry and shrinking margins. The company’s main problem is that it lacks an expressive moat, contrary to rivals in the smartwatch as well as fitness tracker market.
The company’s revenue surged 46% year-over-year in the previous quarter, which signified its slowest growth rate since it became public last year. Surprisingly, 54% of the company’s sales arrived from the latest Blaze and Alta, and two-thirds of activations on both the devices were made by new users. Moreover, sales of accessories related to these two devices also surged 40% successively.
Obviously, the numbers detailed above look good, but the company’s non-GAAP gross margin tapered from 47% a year before, to just 42% during the quarter. Not only this, the company’s operating expenses surged more than twice to 40% of revenues, as well as its non-GAAP net income declined 42%.
This clearly suggests that it is mandatory for the company to spend heavily to grow its revenue, and to save its market share from losing to significant rivals such as Apple (AAPL, Financial) and Xiaomi. With time, rivalry in the wearables industry is increasing, and those escalating expenses could destroy the company’s margin and its probabilities of steady profitability.
As competition in the wearables market heats up, those rising expenses could crush its margins and its chances of stable profitability.
Fitbit is Not Alone in the Market
Two years ago, Fitbit’s foremost rival, Xiaomi, introduced the Mi Band priced at just $15, $85 less compared to Fitbit’s Flex, and offered similar features to the Flex. Moreover, Xiaomi recently introduced its new Mi Band 2, a $40 device which comprises a display as well as heart rate tracking.
Most significantly, Xiaomi is offering high end features at very little cost compared to Fitbit’s higher end devices such as Surge, Charge HR and Blaze.
According to IDC, initially, Xiaomi claimed just 6.2% of the worldwide wearables market in late 2014. However, that figure has reached 19%, detailed in the first quarter of 2016. Due to better product offerings, Xiaomi should continue dominating the market going forward, which is bad news for Fitbit.
Conclusion
Growing competition will hurt Fitbit’s margins going forward. Xiaomi has already taken the lead in the wearables segment and given the entry-point of its devices, I expect it to continue dominating Fitbit.
Disclosure: I don't hold a position in any of the stocks mentioned in the article.
Start a free 7-day trial of Premium Membership to GuruFocus.
