Fitbit Sell-Through Worrisome

Submitted by Seth Golden as part of our contributors program

Fitbit Sell-Through Worrisome

After rising from the ashes in the last couple of weeks, shares of Fitbit (FIT) have exhibited a significant pullback and are up only 10% since reporting beats on the top and bottom-line for its Q2 2016 period. While many place the blame of this seemingly beaten-down consumer goods company on short participation, the longs have a significantly larger weighting in the stock. As such, what has been happening is an undeniable lightening from long participating shareholders. As reported through Scottrade, since Fitbit’s Q2 results were released on August 3^rd, less than 2mm short transactions have taken place.  Even if we assume that half of these transactions came from shorting versus short covering, the volume of straight buy and sell transactions has constituted more than 95% of the trading activity since August 3, 2016.

So why the selling pressure as of late?  Well it is pretty simple and it has absolutely nothing to do with rumors, next generation products, short sellers or even competition.  The fact is that Fitbit sales are falling.  “But Seth, Fitbit reported net sales growth of over 46% during the Q2 period and has always reported sales growth”.  While nobody can deny the rather clear reported results which evidence sales growth, what can be better understood is where the sales growth is coming from and why institutional investors continue to worry about the future of the company.  The growth in sales here and now is expected, understood and of no surprise.  The problem lay within how the company is going about acquiring this growth and what it portends for the future reported results from the company.

Fitbit reports sell-in results,  as do most every consumer goods companies.  Sell-in refers to Fitbit selling products to distributors in certain markets and retailers in others.  What Fitbit doesn’t report is sell-through results or the sales to end users/consumers. The bulk of Fitbit’s sales growth comes almost entirely through sell-in performance.  With Fitbit expanding internationally and in existing markets, this has proven to bolster the company’s sales growth.  But when we pull back the layer of sell-in results and are forced to recognize the sell-through results, we find a disturbing issue with the company’s sales performance. Furthermore, any investor can perform this exercise in analytics; one just needs to know they should.

Readers might recall from my previous publications and from Fitbit’s transcripts that the company has expanded their shelf space significantly in the U.S. and Europe.  In the article “Fitbit Intra Quarter Update”, I demonstrated how Fitbit had almost tripled their shelf space at Target (TGT).

Much like Target, Fitbit doubled their shelf space with a free standing Alta “Special Value” fixture at Wal-Mart (WMT) that supplemented the company’s product position within the Electronics & Entertainment department.

Through advancing shelf space to this degree at existing retailers, Fitbit materially grew its distribution. If we do the math we understand that 3,600 Wal-Mart stores added the Alta “Special Value” fixture and 1,800 Target’s tripled their shelf space for Fitbit products year over year.  As such, Fitbit added the equivalent of 8,900 new retail doors worth millions of dollars in sell-in sales.  This doesn’t even take into consideration the newly expanded Costco (COST) distribution gains for Fitbit’s Alta and Blaze products. And that is the good news.

The bad news is the sell-through results actually validate the bear thesis in the business model. With the distribution gains understood and out of the way let’s look at what the company reported regarding U.S. sales. The U.S. comprised 76% of Q216 total sales.  This represented 42% revenue growth in the region year over year.  New products, Fitbit Blaze and Alta, including related accessories, comprised 54% of Q216 revenue.

Fitbit doubled and in at least one example, tripled its distribution in the United States, but sell-in only grew 42% for the region.  What this suggests is that existing product on the shelf or inventory of Fitbit products is exhibiting negative year-over-year growth.  The new distribution growth that we identified in the United States is the equivalent of a 100% shelf space growth because it is a one-to-one offering of product inventory:sales ratio.  So Fitbit should have been able to report 100% sales growth, at least and if existing inventory at retailers was selling at a faster rate year-over-year.  But the fact is that they didn’t because the existing inventory on shelves exhibited negative sales growth and offset much of the sell-in gains exhibited through distribution growth.  Moreover, NPD data that is released weekly has generally displayed year-over-year sales declines for a greater part of 2016. Investors and traders who subscribe to the data recognize that even though the reporting is only for the U.S. marketplace, the U.S. is where Fitbit garners the greatest sales and will indicate the future potential for the company’s products.

In short, the new products are great for Fitbit because they allowed the company to sell more products to distributors and retailers as they do when they first begin distribution in any region. But the underlying problem is what happens when the company saturates markets on the distribution side and the total addressable market (TAM) side of the coin and finds itself in a position where it can’t grow shelf space any further. Next year, regardless of what new products Fitbit introduces they will not be able to garner more shelf space in the United States as there simply isn’t any more to be had. Retailers aren’t going to give them any more space either given the sell-through rate and as they experience product sitting on shelves for extended periods of time with a market nearing saturation.  NPD data tracks sales of Fitbit and other wearable products week-to-week and has shown a consistent deceleration in sales of fitness trackers.  Even Fitbit subscribes to the NPD data to better understand how the consumer is reacting/engaging with their products at the point of sale.

So when investors wonder why FIT shares don’t seem to excite or exhibit a more beneficial growth multiple given its 40%+ revenue growth rate in 2016, one should understand that sell-in is very different from sell-through. Well-informed and experienced investors know that Fitbit is digging itself a rather sizable hole by pulling a good deal of its sales growth forward into 2016 with all of this expanded distribution and shelf space. It’s one of the reasons that, at present, analysts only expect the company to grow sales roughly 17% in 2017. This is more than a 50% deceleration in revenue growth year over year. So if investing is about the return on capital invested for future years, the future looks far less optimistic for FIT shareholders given the compounding decelerating revenue growth.  This is also why Fitbit shareholders are found lightening up on shares into rallies.

While Fitbit may be modeling for less spending in 2017 and rising average selling prices (ASPs) past the point of market saturation, investors might consider the probability of the company achieving this model. The fact is that no hardware company has ever been able to express rising ASPs post market saturation, not ever with a singular product category. At best they can hope to maintain the current ASP, but most of the time ASPs do nothing but decline until a point for which the vendor’s sales bottom out, establishing a floor for pricing.  The ASP usually declines with the initiation of manufacturers rebates, gift card w/purchase and continued marketing of discounts at the point of sale. The blender category is experiencing a market saturation point in 2016, with NPD data identifying this in the average selling price for products like Ninja, Vitamix, Blendtec and every other brand of blenders exhibiting lower-year-over year pricing.

In my follow-up article, I will help investors debunk the myth about medical grade wearable devices and why this is a road Fitbit should not travel on if they hope to benefit shareholders.  Remember, GoPro (GPRO) was supposed to derive revenue growth from becoming a media company with their millions of Youtube video uploads and viewers.

Disclosure

I am long shares of FIT with a cost average of $13.13 a share.