In June 2022, inflation in America -- as measured by the Consumer Price Index (CPI) -- hit a 40-year high of 9.1% on an annualized basis. That was substantially above the Federal Reserve's target of 2%, so to bring CPI down, the central bank embarked on its most aggressive interest rate-hiking ever.
Both rising interest rates and high inflation have an extremely restrictive effect on people's spending habits, because they're forced to allocate more of their income to debt repayments and essential products while luxury purchases take a back seat. As a result, companies selling goods in the latter category have suffered over the past year.
Sea Limited (SE 0.05%) and GoPro (GPRO 1.17%) are perfect examples. Each company is grappling with its own internal challenges, but they have undoubtedly felt the effects of the recent drop in consumer spending. Shares of Sea Limited have declined in value by 89% from their all-time high, while shares of GoPro are down 97%.
But there might be some good news on the horizon. Some experts predict the Federal Reserve will begin cutting interest rates in mid-2024, and that could spark a comeback in the two aforementioned stocks. Here's why investors will want to own them.
1. Sea Limited is focusing on profitability
The consumer is at the heart of Sea Limited's business. The company's operations are split into three key segments. E-commerce is its largest, followed by digital entertainment (gaming), and digital payments. During the pandemic years of 2020 and 2021, Sea Limited was regularly growing its quarterly revenue by triple-digit percentages, but that growth has stalled completely this year.
The company's gaming business is responsible for a large portion of its overall slowdown. Since pandemic restrictions were lifted, it has experienced a sharp drop in quarterly active users, which is driving a plunge in its revenue. In fact, in the recent second quarter of 2023 (ended June 30), Sea Limited's gaming segment generated $529 million in revenue, which was down 56% from its peak revenue of $1.2 billion in Q2 2021.
The company's saving grace right now is e-commerce. While its hybrid consumer-to-consumer and business-to-consumer platform, Shopee, has experienced a slowdown, it drove a 20% increase in revenue (year over year) for the segment during Q2. That's a much lower growth rate than even one year ago when Sea Limited's e-commerce revenue increased by 51%, but it was enough to offset the dip in gaming and drag its company-wide revenue growth to 5% for the quarter.
Setting aside the broader economic weakness, there is another reason Sea Limited's growth has stagnated lately. In previous years, the company had invested aggressively in customer acquisition and the expansion of its businesses, even if it came at the expense of profitability. But because the cost of capital is now much higher, Sea Limited has instead slashed its expenses and focused on generating profits instead.
For example, in Q2, it reduced its marketing expenses by 49% compared to just one year ago. Naturally, that means it created fewer opportunities to generate revenue growth because it engaged fewer potential customers. It also reduced research and development costs by 23%, which could lead to less innovation and fewer product updates.
But the effects on Sea Limited's bottom line are indisputable. The company delivered $330 million in net income in the second quarter, which was a massive swing from the whopping $931 million net loss from the same quarter in 2022.
Sea Limited stock is trading 89% below its all-time high, and at levels not seen since 2019. But consider this: If interest rates fall in 2024 and consumer spending is reignited, the company could see significant organic growth across its businesses, and considering how heavily it has cut costs, that could drive an explosive boost to its profitability.
2. GoPro could be a fantastic risk-reward play
GoPro's struggles predate the latest challenges in the economy. Its stock is down 30% this year. It listed publicly in 2014, and after hitting an all-time high of $93.85 a short time later, it has declined steadily to just $3.50 today. The company produces action cameras for outdoor enthusiasts, which is a relatively niche market. Plus, manufacturing camera hardware is a one-dimensional business model, so GoPro's revenue growth has often been unpredictable and lumpy.
But the company is in the midst of a transformation. It has introduced subscription services to customers in order to create new revenue streams, which carry much higher gross profit margins than its camera hardware. It has developed a camera editing app for smartphones which is available for $9.99 per year, and it also just released a desktop software version.
GoPro's flagship subscription is targeted toward its most loyal customers. It's priced at $49.99 per year and gives them exclusive product discounts, unlimited cloud storage for their videos, livestream capabilities, and even no-questions-asked camera replacements in the event of damage. As of Q2 2023 (ended June 30), GoPro had 2.44 million subscribers on board, an increase of 27% year over year.
The company says that by the end of 2023, it could generate $100 million in recurring revenue from subscriptions annually going forward, which would represent about 10% of its total revenue. However, because subscriptions carry a gross profit margin as high as 80%, they will likely punch above their weight in terms of profitability.
Plus, to help fuel growth in camera sales, GoPro is reversing some of its pandemic-era strategies. It pulled its products from about 30% of third-party physical retail stores during the height of COVID-19 to focus on online sales, since people weren't visiting malls as frequently. But it's rebuilding its physical presence by entering 800 stores recently, and it expects that number to more than double to 2,000 by the end of 2023.
The move is designed to put GoPro's products in front of more customers, and the early signs are positive. In the second quarter, revenue came in at $241 million, which was 10% higher than its prior guidance.
Wall Street analysts expect GoPro to deliver $1 billion in revenue for all of 2023, which would be down 6% from 2022. However, they expect the company to return to growth in 2024 with a 12% increase in revenue. Considering that GoPro is valued at $533 million today, its stock trades at a price-to-sales ratio of just 0.5, which is near the cheapest valuation in the company's history.
GoPro's new revenue streams will likely bear fruit over the long term, but the company will also benefit from increased consumer spending if interest rates fall in 2024. Therefore, this stock could be a great risk-reward play over the next few years.
