GPRO - GoPro Has Hit A Lull With No Upcoming Catalyst

Summary

• GoPro's Q4 earnings report didn't do anything to help the rerating story the market is still waiting on.
• The company's issues are both external and self-inflicted, with the HERO11 Mini causing me to wince with inventory corrections already a problem.
• The subscription service is the only thing keeping the company afloat and the reason I remain interested.
• But ending production in Mexico gives me pause for the longer-term view of camera demand.
• GoPro is now without a catalyst, one needed internally to change the company's direction, and this has become apparent with Q1's guidance.

A little less than a year and a half ago, I wrote about GoPro's (GPRO) valuation rerating and how the market was waiting on one more thing . That one more thing was a return to consistent revenue growth. What has unfolded since then is consistent, but not the right type of consistent. Its Q4 earnings report was decent, and the company continues to lean itself enough to be profitable on a GAAP basis, but Q1 isn't starting the year on the right foot. Of course, this isn't entirely GoPro's fault as the macroeconomic situation is outside of its control. However, it still means GoPro's catalyst for a rerating and a market-rewarded turnaround is still nowhere to be found.

Two things stand out with the company's performance in its recent earnings report and guide. The first is its continued success in driving subscription and service revenue, and the other is the rather sizable downside guide for Q1's revenue. And as a bonus, a small detail in the company's management commentary about production sites stuck out to me, and it isn't particularly positive.

I'll cover the downside guide first as it's the most glaring in the report.

Weakness In Q1 Is Both External And Self-Inflicted

Working down the chain in building the case for a Q1 guide starts with inventory and sell-through, which impacts the next quarter's ability to ship into the channel, thus affecting revenue. CFO Brian McGee shared in the company's Q4 management commentary , "sell-through was 50,000 units (below expectations) at approximately 900,000 units." This means there was not as much outtake in the channel (units sold) as expected. Therefore, inventory is going to be impacted, which it appears to have been as "channel inventory decreased sequentially, but not as low as (expected), to approximately 685,000 units."

There was some color added to why this was the case.

Due to the HERO11 Black Mini sharing the channel, it contributed to a higher channel inventory. This gives me a sort of wincing moment as GoPro has tried to run with different products simultaneously in the past but tiered for different price points. With the Mini, it's more of a different use case rather than a grab at a different price point because it's only a $50 difference and doesn't necessarily appeal to those looking for "cheaper."

But the risk is for GoPro to fumble the management of two similar products since this is already a black mark on its track record from prior years when it had multiple camera tiers. However, it's difficult to compare to the prior year period since, as the CFO shares, "[c]hannel inventory was also up slightly year-over-year" because of the Mini. So understanding if the Mini is selling well based on this information alone isn't clear. However, since inventory is only up slightly year-over-year and would have otherwise "declined year-over-year," there's at least the understanding the swing wasn't huge with the addition of the new product. But, again, how much it would have declined is unclear.

So how does this get us to guidance?

Well, the hints were laid out with sell-through not meeting expectations and inventory being higher. With those premises, it's not surprising to hear GoPro is dealing with "the macroeconomic environment as well as retailers continuing to reduce their inventory. " Adding another product - which, as you might have guessed, I question the timing of the Mini launch during the toughest time the company has seen in the broad retail market since being public - doesn't help the clearing of inventory. It only loaded retailers with more of it to keep clearing, especially with a huge holiday season of markdowns and discounts.

The company expects "channel inventory to decline in the first quarter of 2023 by nearly 50,000 units as [it] anticipate[s] further inventory tightening by retail and distribution partners." This is leading to a lower sell-in which is why guidance is $165M at the midpoint vs. the consensus of $209.15M - a miss of 21%. This reinforces my concern of releasing a second product which may or may not sell well during a period of arguably the most uncertain retail environment we've seen in a decade and a half.

There's A Current Moving Below The Surface

GoPro's continued growth in its recurring revenue subscriber base keeps me interested and likely the thing keeping the market interested. This is supplemental, high-margin revenue the company is using to continue putting one foot in front of the other.

The company exceeded its subscriber guidance of 2.2M by ending the year with 2.25M subscribers, growing 43% year-over-year. The outperformance here is encouraging as one-time purchases of hardware is turning into recurring software-level margin revenue from the same consumer.

Entering 2023 with a $100M run rate based on the current 2.25M subscribers is a good spot for the company to build upon. The baseline has reached a recognizable goal, approaching 10% of the company's revenue. If this can continue to expand it should somewhat offset retail hardware weakness for the first half until it can rebound and push sales higher in the back half of the year.

Based on the commentary over the last two years and the consistent growth, it's clear the company can maintain a high retention rate and a decently low churn rate. The color provided with the Q4 report wasn't terribly detailed, but what was mentioned showed ongoing improvement.

Additionally, we continue to see improvements in annual subscriber retention which was up 6% from the beginning of the year.

- Brian McGee, CFO, Q4 '22 Management Commentary

So I'm not concerned with the subscriber side of the business, but I'm concerned with the hardware business slowing down enough to where the subscriber adds are affected due to the "attach rates" from hardware sales. This is not a minor matter to gloss over. The funnel for subscribers is through the camera product, and if the camera product is terminally weak then the subscription business won't continue to grow.

But again, the macro environment can't be helped, and it becomes a matter of does the new Mini product help or hurt the inventory battle? Right now, it appears to be a headwind, at least to revenue, but if the pickup is good enough during the first half, it will become a tailwind in the second half.

This Hardware Slowdown Has Legs?

In management's Q4 commentary, I picked up on a small bit of information that concerned me. This goes hand in hand with the slowing of hardware sales I just mentioned.

During the fourth quarter, we incurred a restructuring charge of approximately $8 million related to ending camera production in Guadalajara, Mexico. We expect camera production facilities in China and Thailand to meet future demand .

- Brian McGee, Q4 '22 Management Commentary

This Mexican facility was to work around US tariffs on China and other supply chain risks with China. So why end production there now unless the company was expecting less demand moving forward and is willing to take back on the risk of supply chain issues in Asia?

Not one analyst on the earnings call even came close to asking a question on this topic.

Some answers I come up include the Mexican facility wound up costing more and pressured gross margins, and now is the time to pivot back to remove the headwind. Another answer is the Asian production facilities have increased capacity and can now take on any additional supply needed for cheaper.

But the reasons given for the Mexican facility's purpose in 2019 don't align with my first answer, while it doesn't provide a clear line through the second answer:

As stated previously, our decision to move most of our U.S. bound production to Mexico supports our goal to mitigate the possible impact of tariffs as well as recognize some cost savings and efficiencies in our supply chain.

- Brian McGee, Q2 '19 Earnings Call

The Mexican plant's output was for US-bound sales to avoid US-sanctioned tariffs on China and to improve its supply chain efficiencies. But now, with the winding down of the facility, all products will ship from either China or Thailand. This is one less production facility, meaning capacity is now capped at what the Asian facilities can deliver with the supply chain risks they carry. This brings me to a third answer - and a serious concern - is the company ramping down supply for a longer-term downward trend?

This is obviously a problem if the company is willing to take back on the tariffs since they haven't been lifted by the Biden administration. I contacted GoPro's investor relations and asked the question:

...I am curious for the reasons of ending production in Mexico. Is it due to needing less supply or something along the lines of higher costs coming with producing in Mexico? How does this reason align with the original reasons for the need of the facility in Q2 of 2019 to avoid Chinese tariffs?

As of writing this article, GoPro has not responded. However, I'll post an update with a pinned comment on this article if and when they do.

Nothing Doing And No Near-Term Catalyst

GoPro is a cautionary tale at the present time, and not because it's all in GPRO's control. The product timing is questionable, but the macro factors are expected. I disagree with marketing a new product when inventory is a huge issue in retail - perhaps if it launched only at GoPro.com, I could get behind it. Retail, in general - and, by virtue, GoPro - is not a great place to invest right now, except if you expect a better second half and a recession to remain out of reach.

There's no clear catalyst on the horizon except the gradual change in inventory normalization, but there are no guarantees it happens and happens on the timeline expected by the companies we've heard from thus far this earnings season. With GoPro hurting its own inventory timeline and reducing production facilities, I question what the long-term holds.

In the meantime, the need for consistent higher revenue growth for a stock valuation rerating has been met with consistent flatlined-to-slightly-negative growth with an aimlessly wandering stock price. For now, I'll maintain my stock position and wait to see how the dust settles.

Leaning out the company and squeezing operating efficiency isn't a long-term option and can only do so much if things get progressively worse. GoPro needs a catalyst to generate revenue growth outside of waiting on the retail market to cycle back around, and this means it must come from within. I don't know what it is. Hopefully, Nick Woodman does.

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