Give credit where credit is due. Long-struggling GoPro (NASDAQ:GPRO) is making progress. And it’s reflected in GPRO stock, which now has risen over 50% so far this year.
Of course, the problem is that GoPro stock closed 2018 only a few pennies off an all-time low. The big rally has only returned GPRO to where it traded at the beginning of November, ahead of yet another disappointing earnings report.
That said, Q4 earnings — and 2019 guidance — were much stronger. GoPro is tracking toward profitability in 2019, if only on an adjusted basis. There is some good news here in a stock that I’ve long viewed with skepticism.
The question after the rally is whether that good news is already priced in. For the most part, it is. GoPro still has real questions — and back above $6, GPRO stock simply doesn’t look quite compelling enough.
Case for GoPro Stock
Admittedly, the outlook is brighter for GoPro. Q4 numbers were strong, with sales up over 12%, capping off a year when revenue dropped just 2.7%. Cost-cutting — non-GAAP operating expenses dropped 17% in 2018, according to the Q4 call — helped margins, allowing GoPro to revert to profitability on an adjusted EBITDA basis.
In 2019, revenue growth is expected to return, with the company guiding for a 5-8% increase in sales. And GoPro expects to move to non-GAAP net profitability, with EPS guidance of 20-40 cents. The big driver is an enormous expansion in adjusted gross margin, which is expected to rise from 32.8% in 2018 to 35-37% in 2019.
That gross margin expansion, in particular, gives added reason for hope. It shows that GoPro is able to sell more cameras at higher prices and rely less on discounting to move units. GoPro has had some issues over the years overbuilding inventory, and then clearing that product through outlets like Best Buy (NYSE:BBY) at unattractive prices. At least at the moment, management doesn’t expect a repeat in 2019.
The Subscription Business
The other trend boosting margins is the company’s growing subscription business. Those revenues have higher margins and are growing nicely, with paid subscriptions rising 50%+ last year.
So there is a bull case here — which truthfully hasn’t always been the case. Revenue is growing, both domestically and overseas. On the Q4 call, CEO Nicholas Woodman cited improving market share figures in Europe and Asia. Both gross margin and operating margin – the latter thanks to better spending controls – should expand.
And with GoPro now targeting profitability, valuation suddenly doesn’t look so extreme. The midpoint of 2019 EPS guidance suggests a P/E multiple of 21x. That’s not stunningly cheap, to be sure. But if GoPro is building a base for continued earnings growth, it’s cheap enough.
The Concerns with GPRO Stock
That said, the big concern here is whether earnings growth is going to continue. Assuming the company meets 2019 guidance, operations will have improved significantly between 2017 and 2020.
But what happens from there? Gross margin expansion is likely limited; CFO Brian McGee said long-term gross margin targets were 36-39%, pretty much in line with 2019 expectations. The company can’t bring down opex every year without skimping on needed R&D and marketing spend. There’s room for savings on interest expense if GoPro can pay its debt off a few years from now, but after-tax even that represents something like 10-12 cents in annual earnings per share.
From a growth standpoint, the easy work has been done. Post-2019 — again, assuming guidance has been met — GoPro simply has to grow sales. And the worry there is that the company really hasn’t shown a consistent ability to do so. In fact, few hardware companies have.
IP camera manufacturer Arlo Technologies (NYSE:ARLO) has plunged after its spin-off from NETGEAR (NASDAQ:NTGR). GoPro often is compared to Fitbit (NYSE:FIT), which went public around the same time, similarly soared, and then collapsed.
Consumer hardware simply is a hugely difficult business. Sales depend essentially on the replacement cycle. That seems doubly true for GoPro, whose market is limited. ‘Action cameras’ simply have a fixed demographic. Consumers will age into that demographic — and also age out.
GPRO as a Revenue Story
But at 20x+ earnings, with margin improvement opportunities limited, GPRO stock now becomes a revenue story. And that seems dicey. GoPro hasn’t shown sales growth: 2019 revenue guidance suggests sales will be ~12% lower than they were five years earlier. Market growth is unlikely. It already has 90%+ share of Western markets, which means market share gains are limited as well.
With profitability and some growth, GPRO likely can grind out some upside. A sale could drive returns – but there’s no obvious acquirer, or any sign that Woodman (also the founder and controlling shareholder) is interested in being taken over. As a standalone, for real returns in GPRO stock, sales need to grow for several years to come. It’s possible — and it looks more possible now that it did a year ago or three years ago.
‘Possible’ isn’t enough to make GoPro stock compelling, however. Gains from here still requires consistent revenue growth. And for those investors who have followed the company since its IPO, consistency has been the one thing the company has never been able to provide.
As of this writing, Vince Martin has no positions in any securities mentioned.
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