Fitbit Inc (FIT) Stock Is Going to Burn Amid Flex 2 Explosion Report

Fitbit Inc (NYSE:FIT) has declined for nearly two years straight. After hitting an all-time high of $47.60 in July 2015, FIT stock now trades below $6. The culprit? Falling sales and a reversal of profits to losses, capped off by a disastrous fourth-quarter report in February. And now, Fitbit could fare even worse, as the company might be facing its “Samsung moment.”

Fitbit Inc (FIT) Stock Is Going to Get Burnt on Flex 2 Explosion Reports

Reports out today say a Wisconsin woman claimed her Fitbit Flex 2 tracker caught fire on her arm while she was sitting and reading.

“She said she ripped the device off of her arm as it was still burning and tossed it onto the floor,” ABC News reported. “Mitchell said her doctor had to pick pieces of plastic and rubber out of her arm after the incident.”

Fitbit says it’s investigating, and FIT stock is actually overcoming the news for now, up 1% among a few things, including optimism over a possible partnership with the U.K.’s National Health Service.

But even if this ends up as an isolated incident, things aren’t getting any better for FIT stock — not soon, and maybe not ever. Samsung Electronics (OTCMKTS:SSNLF) was crushed amid its Galaxy Note 7 explosions, and that’s a diversified technology giant. Fitbit is focused on wearables, and little else.

This only adds to its mounting difficulties in that wearables market, where competition is intensifying and Fitbit already can’t hold pricing. Profits are increasingly elusive, and there’s little reason to expect improvement on that front.

Fitbit Is Really, Really Unprofitable

The most important thing to keep in mind regarding FIT stock is that right now the company is massively unprofitable. That in and of itself doesn’t doom the bull case for Fitbit, of course. Stock prices are based on future earnings, not past profits.

But it’s worth considering just how much Fitbit profits have to improve just to get to breakeven.

In 2015, the company’s adjusted EBITDA was $389 million. In 2016, it was $30 million — 1/13th of 2015 levels. Guidance for 2017 suggests a loss of as much as $100 million – and that excludes another $100 million-$110 million in stock-based compensation.

In other words, to get to breakeven on a “true” basis — and not just in terms of cash flow created by stock issuance — Fitbit needs about 1,200 basis points’ worth of margin expansion at current revenue levels. The company already has cut $200 million in operating expenses. Gross margin is guided to 43% or so in 2017 — against 39.3% in 2016 and 48.5% the year before. Fitbit stock needs to get gross margins back to its peak and grow sales and manage expenses in a way that its revenue growth in 2018 and beyond leverages SG&A.

And that still might not be enough to get to breakeven.

Wearables Growth Is Questionable

Obviously, Fitbit needs some help from growth in the wearables market as a whole to get there. Expecting revenue growth in a flat or declining market is far too optimistic.

Is that growth coming? Perhaps. But market growth projections continue to come down. Fitbit itself has sold 43.7 million devices in the last two years alone — one for every roughly eight people in the U.S. There are international opportunities, but 71% of 2016 revenue came from the U.S., according to the Fitbit 10-K. That figure was flat year-over-year, implying that Fitbit’s weakness is a global phenomenon.

Personally, I don’t see the use case for wearables. And there’s little doubt that smartphones will continue to add some of the features being provided by Fitbit, further pressuring that use case.

From the standpoint of FIT stock, the question is whether Fitbit can drive penetration beyond early adopters. Fitness aficionados may love their Fitbits … but they aren’t enough to drive a turnaround in shares.

Competition Is Brutal

If wearables market growth slows, then Fitbit needs to at least maintain market share to drive revenue growth. And that means it has to outcompete Apple Inc. (NASDAQ:AAPL), which seems highly unlikely. It also has to fend off Garmin Ltd. (NASDAQ:GRMN), who clearly has taken share from Fitbit over the past few quarters.

The problem is competing with those two companies means Fitbit has to maintain pricing discipline.

Pricing collapsed in Q4, however, with Fitbit forced to give rebates to retailers like Best Buy Co Inc (NYSE:BBY) to move product. That led non-GAAP gross margin to fall by more than half in the quarter.

If Fitbit can’t take pricing — and that seems likely — then gross margins won’t expand. If gross margins don’t expand, then revenue growth has to be tremendous to drive the operating leverage needed to get the 1,000-1,200 bps improvement and get Fitbit back to breakeven.

But without pricing, revenue growth has to come from volume. And if the wearables market is slowing, then volume won’t increase enough.

It’s a vicious cycle for Fitbit — and a huge problem for Fitbit stock.

Sell FIT Stock Without Delay

On top of those structural problems, Fitbit isn’t executing all that well; 2016 was a disaster both in terms of numbers and in shareholder communication. Production delays popped up in Q1, with Fitbit struggling to make its new smartwatch fully waterproof. Those delays push Fitbit’s launch right into the window of the new Apple Watch — a potentially huge problem in terms of driving demand and buzz.

Meanwhile, Fitbit is a single-product company — and in the modern tech world, that’s a problem. GoPro Inc (NASDAQ:GPRO) has had similar problems expanding beyond its legacy product, and has seen its stock suffer as a result.

Now, Fitbit has to deal with the potential fallout from product explosions. It’s early on, and this could end up fading quickly if this is found to be a one-off event, but it sure doesn’t help.

Fitbit simply doesn’t have a clear path back to breakeven, let alone profitability. The company does have $660 million in cash and investments, but it will burn some of that money in 2017 and likely 2018 as well. Fitbit probably should sell itself, but as I argued in February, it probably won’t.

There’s simply not a bull case here that makes any sense, beyond FIT stock being “cheap.” But the declines in FIT stock aren’t the result of a panicked market. They’re the result of investors understanding that Fitbit, as a company, is in big trouble.

That’s not going to change any time soon — if ever.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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