Morgan Stanley Discusses Fitbit Initiation, Notes 'Large Opportunity' But Valuation Concerns

In a video published Friday, Morgan Stanley analysts Katy Huberty and James Faucette discussed their recent initiation of Fitbit Inc FIT with an Equal-Weight rating with a $42 price target.

According to Huberty, Fitbit is a "leader" in the "very large and growing" wearable market that should actually be considered a "mainstream category" with plenty of room for growth. In fact, wearables have a current 24 percent penetration rate and is approaching the 28 percent penetration rate of notebooks. Meanwhile, tablets hold a 49 percent penetration rate while smartphones stand at 67 percent.

With that said, Huberty is estimating the wearable segment will see a 50 percent compounded annual growth rate through 2020 with sales of wearables reaching 530 million units. However, Fitbit is projected to see its current 57 percent market share dip to 16 percent by 2016 and continue falling to an eight percent market share in 2020.

The analyst explained that Fitbit's market share loss will be attributed to new entrants in the market and growing competition from existing peers. However, despite the expected market share decline, the company will still experience an 18 percent compounded annual growth rate through 2020.

Faucette also pointed out that Fitbit's margin has further room to expand. The company's 48 percent gross margin is higher than GoPro Inc GPRO's 45 percent but trails Garmin Ltd. GRMN's 56 percent.

Is Apple A Threat To Fitbit?

Huberty discussed Apple Inc. AAPL's launch of its Apple Watch and how it could affect Fitbit. The analyst pointed out that Apple is gaining "mindshare" (i.e., consumer intention to purchase) but did note the market is large enough for both companies to succeed over the long-term.

The analyst also suggested that Apple "mis-executed" on its Watch launch through distribution errors and by failing to properly educate its customers. As such, in the near-term, Apple's competitive threat to Fitbit is not as severe as many would have thought.

Valuation Concerns

Faucette noted that his "bull case" valuation ($60 price target) implies a 24 times P/E multiple on 2016 earnings while a "base case" valuation ($24 price target) implies a 20 times multiple. The analysts $42 price target is the mid-value of the bull and base case.

Faucette pointed out that his multiples are "generally in-line" with several other consumer companies such as GoPro's 26 times multiple. In fact, shares of Garmin are trading at a 14 times multiple which is justified as the company has struggled to show "any growth at all" while Fitbit is showing no issues with its growth.