Zepp Leaves Investors Guessing With Return To Profits, Tumbling Own-Brand Sales

Key Takeaways:

• Zepp returned to profitability in the third quarter for the first time since 2021, as its margins jumped with the development of its own Amazfit brand
• The company’s shares initially rose sharply after the report, but then fell even more, as investors worried about a big drop in sales of its own-brand products

By Doug Young

We don’t usually spend too much time on companies worth less than $100 million, since such low valuations often indicate investors aren’t interested in such stocks. But Zepp Health Corp. ZEPP seems worthy of an exception, as the company’s stock looks massively undervalued despite the considerable progress it’s making in transforming from a manufacturer of third-party brands to developing its own brand.

The maker of wearable health devices released its latest financials at the start of the week, which buoyed its beaten-down shares by 10% as it reported a return to profitability after six quarters of losses. But then the stock tanked by an even larger 17% on Wednesday just before the Thanksgiving holiday, wiping out all the earlier gains and more.

This kind of wild swing probably reflects the fact that only smaller, less-sophisticated traders are buying and selling the stock right now, and don’t know what to make of the mixed signals coming from the latest earnings report. From our perspective, the bigger signals look generally positive, though there were definitely a few red flags.

The big story is that Zepp is a Chinese company trying to look more global in the fast-growing market for wearable sports devices. It began its life in 2013 primarily as a manufacturer of wearables for smartphone maker Xiaomi (1810.HK), and, reflecting that focus, was known by the similar-sounding Huami name at that time.

But the company began developing its own brand a couple of years ago, when it changed its name to Zepp, seeking to lower its reliance on Xiaomi and also reap the far fatter profit margins that come with own-brand sales. Its main brand now is Amazfit, which is generally well-regarded as a budget brand among a wide range of products that runs from Apple AAPL watches at the top end, to rival products from Garmin GRMN and Google-owned (GOOG.US) Fitbit.

With such big names as its main rivals, perhaps it’s not too surprising that investors are somewhat skeptical of Zepp’s chances for success. But as we’ve already noted, the company’s Amazfit products seem relatively well regarded as a lower-cost alternative to the much pricier options from its rivals.

That leads us into a closer look at Zepp’s latest results, which show that its journey into own-branded products is moving forward, though not always smoothly. The company’s revenue tumbled by about half to 602 million yuan ($85 million) in the third quarter from 1.21 billion yuan a year earlier. Significantly, that figure was at the very bottom of its previous guidance for 600 million yuan to 800 million yuan, a weak signal in a world where companies often “lowball” their guidance to give them more room for an “upside surprise” with their final results.

Zepp said much of the decline came from tumbling Xiaomi-brand sales, which plunged nearly 60% to 1.7 million units. But its self-branded products also fell by 35% to 1.1 million units sold, which obviously isn’t a good sign for a new emerging brand like Amazfit. Notably, that big decline marked a sharp acceleration from the 7.3% decline in self-branded product sales in the second quarter.

New Products

People who follow tech gadget makers know that sales can vary widely, even for big names like Apple, since sales tend to spike right after new product launches and then go down slowly after that. Such cyclicity seems to be at least partly behind Zepp’s big decline in self-branded product sales in the third quarter, and the company noted on its earnings call that it launched two new products in October that should help to boost its fourth-quarter sales.

It forecast it would record fourth-quarter revenue of 600 million yuan to 850 million yuan, which would represent a 32% decline from last year’s 1.07 billion yuan at the midpoint. That seems to show the sales declines could be easing, though we should note the decline could be as big as 44% if the company’s revenue comes in at the lower end of its range again.

Managers said on Zepp’s earnings call that performance was strong in the Americas in the third quarter, but noted things were weaker in Asia and its Europe, Middle East and Africa (EMEA) regions. We expect the biggest weakness came in Zepp’s home China market, which is big for Xiaomi-branded products and is currently suffering from consumer caution as the country’s economy slows sharply.

While the revenue trends look a bit rocky, things were much better for Zepp in terms of profitability as higher-margin self-branded products took up a bigger proportion of its sales. The company said its gross margin reached 33.9% for the quarter, a huge improvement from the 19.1% a year earlier and a record since its founding a decade ago.

That huge improvement helped to lift Zepp back into the black for the first time since 2021, with the company reporting a small profit of 3 million yuan. The company doesn’t appear to be facing any looming cash crunch, since it has been cash flow-positive for the last five quarters and has nearly 1 billion in its coffers – roughly double the size of its current market cap.

Zepp’s latest valuation metrics look ridiculously low, including a forward price-to-earnings (P/E) ratio of just 3.1 and a price-to-sales (P/S) ratio of 0.14. Its closest publicly traded peer is Garmin, which trades at a much higher forward P/E of 20 and P/S of 4.57.

Zepp still faces an uphill road to even coming close to Garmin’s ratios, but it does seem like the company has laid a foundation for such a journey. The sharply falling sales for its own-brand products looks a bit troubling as it makes its transformation. But at least some of that could be related to the cyclical factors we previously mentioned, which should become clearer if its own-brand sales declines moderate in the fourth quarter with the new product launches.