GoPro (NASDAQ:GPRO) investors breathed a huge sigh of relief after the company's fiscal first-quarter results turned out better than expectations early last month. This seemed to vindicate the company's strategy of ditching its Karma drone business, which allowed it to cut expenses significantly. Selling more action cameras this time on the back of a stronger marketing push, as well as the launch of a budget device, helped GoPro keep the top-line slide in check.
The company's revenue fell just 7.4% year over year, half of what Wall Street was originally anticipating, so it wasn't surprising to see why the bulls applauded the results. But a closer look indicates that the action-camera specialist's turnaround might not be sustainable.
GoPro is losing pricing power
GoPro's action camera shipments rose to 758,000 units during the latest quarter from 738,000 in the year-ago period. But the company had to rely on the $199-priced Hero to move so many units this time.
GoPro's gross margin fell 9.2 percentage points year over year to 22.2%, which isn't surprising given that the average selling price (ASP) of its action cameras fell nearly 10% year over year to $267. GoPro blames this drop on its exit from the high-margin drone business, as well as its strategy of capturing more customers by selling a cheap but feature-rich action camera. But sadly, that's the way the company has decided to go now.
GoPro plans to stick to its strategy of selling action cameras at three price points -- $199, $299, and $399. However, CEO Nick Woodman made it very clear that GoPro's entry-level device will be the one driving sales growth, as the company plans to start distributing the Hero through big-box retailers Walmart and Target in the second quarter.
This means that GoPro isn't worried about losing its premium action camera status and is willing to become a mass-market company instead. So don't be surprised if the company's average selling price trends even lower, inching closer to the $200 mark.
What's more, GoPro has been known to discount its products in order to clear inventories. The company has done this on a few occasions in the past after building too many cameras that went unsold. It will take just one misstep for GoPro to overestimate demand, offer deep discounts, and slash the price of the Hero to even lower levels, suffering further hits to profitability in the process.
The company could be facing such a prospect very soon, as it plans to launch new, higher-margin products just in time for the holiday quarter. GoPro believes that these new products can push its gross margin into the 30%-plus range thanks to lower development costs, but even then, GoPro won't be a profitable business, as it is looking to win over customers through marketing instead of innovation.
Moving toward mediocrity
GoPro is busy cutting costs because it badly wants to break even after failing to make money for so long, despite being a pioneer in the action-camera space. The company wants to keep its operating expenses below $400 million this year, compared to $548 million in 2017, but this also means that it will have less money to spend on research and development.
In fact, GoPro's R&D spending fell nearly 23% year over year last quarter. The company decided to funnel the cost savings from layoffs and the drone exit into marketing campaigns, and it plans to keep doing the same. Woodman will ramp up marketing spend every quarter leading into the holiday season, but the company will maintain its $400 million operating expense cap.
This means that GoPro will be cutting corners as far as R&D is concerned, which isn't a good idea -- it will keep losing its competitive edge to the low-cost Chinese competition that's already clipping at its heels. In fact, a higher R&D outlay in the past has generally led to an increase in GoPro's sales, aside 2016, when it discontinued three of its budget action cameras that were cannibalizing sales and spent the money on the development of the now-discontinued Karma drone.
The company went on the defensive in 2017 after a terrible showing the year before, launching the Hero6 Black and the Fusion 360-degree camera in a bid to improve flagging sales. But the Hero6 was more of an incremental upgrade, while the $699-priced Fusion isn't helping much to drive sales as the decline in GoPro's average selling price indicates.
Playing defense isn't the best strategy
GoPro seems to have lost its innovative edge -- as such, it has prioritized marketing to survive in a space that's been commoditized by an invasion of Chinese manufacturers such as SJCAM and Xiaomi. So it won't be surprising if the company's focus on selling lower-cost cameras backfires, as the competition in the budget action camera space is more intense, with new start-ups popping up quite often.
This is why investors need to accept that GoPro won't be able to hit its lofty margin expectations and will remain in the red until something big comes along. As fellow Fool Travis Hoium points out, the company will need to ship five million cameras to hit breakeven at a 30% gross margin. But with its current margin profile and declining average selling prices, it will need to sell much more than that.
Unfortunately, GoPro is currently on track to sell only three million cameras this year at last quarter's run rate. The latest rebound will likely prove itself to be a mirage more than a sustained rally.