Garmin: Growth at a Reasonable Price?
For those unfamiliar, Garmin is the leading manufacturer of global positioning system (GPS) devices worldwide, with over 50% market share. The company sells products in 3 segments. Automotive, which consists of in-dash or mounted units in vehicles, accounts for 70% of revenues. Personal navigation devices (PNDs), which are handheld units used mainly by outdoor enthusiasts, make up 20% of sales. Garmin's venerable aviation unit, 10% of sales, builds devices for use in aircraft cockpits.
It is not difficult to see why Garmin was a popular growth stock. The GPS market has taken off over the last 5 years, as prices for automotive and handheld devices have fallen, attracting the interest of consumers. Garmin has grown revenues at a 53% annual clip since 2004, and earnings at an eye-popping 50% per year. This growth is expected to continue over the next few years. Even in 2007, only 10% of vehicles sold in the U.S. and Europe had navigation devices, leaving a large addressable market. As auto manufacturers continue to compete on features, GPS devices figure to see unit growth. Handheld units are expected to show similar growth, with gross sales projected to triple by 2012. Clearly, organic market growth is on Garmin's side.
Two other things Garmin has going for it are management and financial strength. The company is run by co-founder, CEO, and Chairman Min Kao. Kao is deeply vested in his company, owning 20% of the shares. That's 1.8 billion dollars in personal wealth, so we can be sure he cares about the stock price! Insider ownership is part of the culture, as executives and board members own nearly 50% of the company. Governance is good also. Despite Garmin's excellent performance over the past 5 years, compensation is very reasonable. Management focuses on free cash flow and return on capital, which are the two things that all businesses should be focused on (not earnings per share, which are easily manipulated).
This great leadership is reflected in Garmin's financial health. The firm has 616 million in cash with no debt, has delivered over 50% average return on capital and 23% free cash flow margins since 2003. How many technology based growth companies can you name that pay a dividend? Garmin does, and at current prices it's a market average 1.8% yield. Not too bad for a company expected to deliver 17% annual gains over the next 5 years.
It's pretty clear we have a great company, and statistically speaking it's quite cheap too. What are the weaknesses? In a word: competition. While Garmin might be a good company, it's not operating in a particularly attractive business. Prices on GPS devices are falling rapidly - Garmin's gross margin has fallen from 58% in 2003 down to 46% in 2007. If these devices level out at standard consumer electronics margin levels, Garmin is looking at a high 20% gross margin in a few years, which will significantly erode profits. In addition to direct competitor TomTom, the big consumer electronics companies like Sony (SNE) and LG Electronics have begun to introduce GPS units of their own. More competition leads to lower prices and increased spending on marketing and R&D to stay a step ahead. There are few ways for Garmin to build a lasting moat around their business. What's more, many believe the PND category is threatened by cellular phones, several of which now have GPS capability. While Garmin is planning to introduce a GPS phone of their own, it will be difficult for them to compete in this space with little experience and established competition like Nokia (NOK) and Apple (AAPL).
MagicDiligence really likes Garmin's revenue growth potential, outstanding management team, and financial performance. To be clear, there are a LOT worse stocks on the Magic Formula screen than this one. And at the company's current depressed price, I think it's more likely than not that Garmin will do pretty well for shareholders from here. However, with it's profits under attack from all sides, the future is unclear. MagicDiligence is looking for sustainable returns on capital. Whether Garmin can sustain it's 50% market share is a question no one can answer with any degree of certainty. Without this reasonable assurance, I can't recommend Garmin as a Top Buy.
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