GoPro Is Valued For High Growth Rates, But From Where?

GoPro sells cameras largely into the action sports market

GoPro (GPRO, Financial) develops and markets cameras and software to consumers to capture, manage, share and enjoy. The company’s line of HERO cameras, premium accessories, Wi-Fi remote and LCD touch BacPac are largely used to capture action activities. Its line of helmet, handlebar, roll bar, tripod and dashboard mounts make it easy for its users to record first-person videos and take videos of action sports.

The company sells its products through retailer, wholesale distributors and its website. It has a YouTube channel and other approaches to help engage its user base. The YouTube channel did see published video increase by 160% in the most recent quarter. Recent sponsored events include the GoPro Mountain Games in Vail, Colorado, X Games and SXSW in Austin, Texas.

The company raised $427 million through an IPO in June 2014. It was founded in 2004 and is based in San Mateo, California.

Growth rates do not support current valuation

Current consensus is for EPS growth of 23.5% in 2015. The current valuation based on forward P/Es of 83x and 67.2x FY14 and FY1, respectively, is too high. In the following peer table, we looked at high-growth tech peers and consumer electronics manufacturers to compare earnings growth and valuation using a PEG ratio. The PEG ratio for GoPro of 2.9 is above both the geometric mean and average of 1.2 and 1.7, respectively. The growth rates based on current estimates do not support the current share price based on this. Facebook (FB, Financial), LinkedIn (LNKD, Financial), Netflix (NFLX, Financial) and Skullcandy (SKUL, Financial) all stand out as companies with higher growth but lower P/Es and PEG ratios. GoPro is expensive.

Source: Estimates are Consensus from Thomson Reuters

In addition, we also looked at sales growth rates and EV/Sales multiples to better gauge GoPro’s current valuation.

At 7x and 5.8x EV/Sales based on 2014 and 2015 respective consensus estimates, the stock is more fairly priced on this basis but still lacks upside on this metric in our view.

However, in our view the more limited market size than most of these companies and lower earnings growth outlook is a significant overhang. The share price of GoPro, even if estimates for 2015 increase by 10-15%, is still too expensive. In addition to valuation, we also see the following growth issues presenting the biggest hurdles for GoPro.

Growth rate is declining

Sales at GoPro have grown rapidly since it started. It had top-line growth of 124.8% and 87.5% in 2012 and 2013, respectively. GoPro has received relatively rapid adoption of its camera products by the action sports community both in the domestic and international markets. Its cameras are viewed as the go-to brand currently by this group. However, growth expectations for 2014 and 2015 have tempered from historic levels. Current analyst consensus forecasts are for sales growth of 25.8% and 21.8% in 2014 and 2015, respectively.

Source: SEC Filings, Yahoo! Finance

In 2Q14, the company reported revenue of $244.6 million, an increase of 38% year over year, highlights a lower growth environment. That said, the gross margin did expand by 990bp and 110bp sequentially.

Source: Company documents

Lower growth rates for a stock with this valuation is concerning. It is facing some challenges and impediments to future growth. One is from new entrants into its markets; the second is from the increasing quality of camera phones like Apple’s (AAPL, Financial) iPhone, and the third is based on its need to increase the size of the addressable market.

The growing size of the portable and mountable camera market has not gone unnoticed by larger electronics firms. For some time, it was viewed as a niche space, but it has surpassed that. Sony (SNE, Financial), HTC and Samsung (SSNLF, Financial) have all taken notice. HTC announced on Sept 12, 2014 that it was developing its first camera, a waterproof model for extreme sports to diversify beyond smartphones. It will have a 16 megapixel sensor and connect directly to devices running Google’s Android and Apple’s iOS.

New entrants into the market are not good for GoPro and will increase pressure on margins for the foreseeable future. While its products are respected, these larger firms can develop similar technology, and some already have. The increasing choices in this market, like any, will drive down margins through lower pricing from increased competition.

Also, the new iPhone 6 and 6 Plus offer improved cameras with better sensors. As smartphones continue to improve their camera features, it presents another threat to GoPro. Some consumers may decide to use their smartphone or tablets instead of a GoPro like camera. The new iPhone features an 8-megapixel camera with an f/2.2 aperture and 1.5µ pixels with an improved sensor from the prior model. It offers DSLR-like phase detection autofocus, twice as fast as the 5s. Also, the 6 Plus provides optical image stabilization, the first iPhone to do so. While mobile phones are not necessarily an immediate threat, they can erode GoPro’s core business over time.

The size of the addressable market remains uncertain and with new entrants, GoPro will get a smaller piece of that pie. The issue that management at GoPro needs to address is where else it can look for growth. It needs to find other applications, ideally that have a larger potential users base like automobiles or police vehicles. The challenge is most people, and police do not need a camera with that quality to record events.

Source: SEC Filings, Yahoo! Finance

Technical analysis is positive, Timing may not be right for short

The following quick review of the technical is all positive based on the RSI, MACD and stochastics. That said, the chart does point to risk outweighing reward. We view downside risk potentially back to the 50-day moving average if sentiment shifts, growth tempers, or the company misses quarters and expectations. Based on our earlier valuation work, we have a hard time supporting the current share price, rather the less, making an argument for over 30% upside, so the risk does outweigh the reward in this case.

Source: StockCharts

Conclusion

GoPro shares are up 139% from its IPO price, and the valuation is too rich at this point. The shares are priced for everything to go right, and we do not see that happening. Pressure for new competitors and smartphones will weigh on earnings growth. The risk outweighs the potential reward on GoPro and while the timing may not be right for a short, we would definitely not be buyers at these levels.