A Short Trip for Garmin?

Garmin Ltd. (GRMN) is a company that specializes in global positioning systems (“GPS”) technology, specifically stand-alone GPS receivers for automobiles. In fact, Garmin is so synonymous with GPS technology that Garmin is the first result on Google (GOOG) when searching for “GPS”.

After appreciating from the single digits in 2002 to reaching its all-time high of 125.68 in late October 2007, Garmin stockholders have watched Garmin’s share price plummet to 14.40 before stabilizing in the low twenties. In 2009, Garmin is down 45.0% whereas the S&P500 is down “only” 26.6%. This previous high-flier has certainly fallen out of favor on Wall Street but was this just a case of heightened expectations crashing down as the economy weakened, or were there fundamental problems behind the decline? Also, were there any signals that could have alerted investors that Garmin’s stock price in October 2007 was unjustified?

I will analyze the current events in the industry, examine the fundamentals of the company with a focus on the financial statements, and finally assess the valuation of the company for a potential long-term investment. So buckle up, and we will be arriving at our destination shortly. Next stop: an informed investment decision.

In the start-up phase of the industry, Garmin had only two major competitors TomTom (TMOAF.PK) and MiTAC International (creator of the Magellon brand). Growth prospects were abundant and virtually all companies were able to achieve success. Unfortunately for Garmin, this industry quickly attracted competitors with deep pockets. Today, technology heavyweights including Apple (AAPL) and Research in Motion (RIMM) offer smartphones with navigation abilities that rival the capabilities of dedicated GPS devices. For example, turn-by-turn GPS navigation applications exist for both platforms.

Factoring in the knowledge that GPS units are priced similar to the increasingly popular smartphones, the GPS companies are facing a serious threat. There is no masking the fact that Garmin has seen its core business come under increasing pressure from smartphones: the pressure is quickly reaching critical mass as smartphone adoption increases. There is little doubt that Garmin will pursue strategies to profit from this shift in consumer preferences but it may be too little, too late. TomTom’s response was to announce a turn-by-turn GPS navigation kit for the iPhone last month.

On the other hand, Garmin is still pursuing the oft-delayed Garmin Nuvifone (a product similar to the iPhone) but with a MSRP of $499.99, does anyone really think that Garmin can demand such a premium over Apple's iPhone? Garmin has a strong brandname, but its not that strong. GPS technology is quickly becoming a commodity and it is clear that Garmin is straying far from its core competencies if it attempts to enter the smartphone market (especially during such a weak economy).

A cleverly titled article written last week in the New York Times discusses the GPS unit versus smartphone debate quite well.

“High-end phones like the BlackBerry from Research in Motion and the new Palm Pre increasingly come equipped with features common in portable navigational devices, like spacious touch-sensitive screens, intuitive menu designs and improved audio capabilities.

'The smartphone has made a lot of progress in the last year,' said Dominique Bonte, director of navigation research with ABI Research. 'It gets very close to what people expect from the experience of the personal navigational device.'”

Turning to Garmin’s financials, at first glance the income statement indicates strong year-over-year growth in sales as revenues have more than tripled from 2005 to 2008. Upon further investigation, the deterioration in margins is quite alarming. Both margins have declined by ten percent in the examined period. This signals increasing pricing pressures and explains the growth in sales. As the company shifts more towards selling software rather than hardware, the margins should improve but the damage has been done.

	TTM	2008	2007	2006	2005
Gross Margin	46.3%	46.7%	48.0%	52.2%	56.3%
Profit Margin	19.4%	21.0%	26.9%	29.0%	30.3%

The release of the Nuvifone should certainly improve margins if it is released at that price point. The last line item worth noting on the income statement is that research & development expenses are keeping pace with sales over the period. The true question is with R&D at only $200M in 2008, can the company possibly keep pace with the aforementioned tech powerhouses? For comparison, Apple spent more than five times as much on R&D in 2008 and Research in Motion spent three times as much in the same year.

iPhone Timeline

iPhone Version	Date
Version 1.0	June 29, 2007
3G	July 11, 2008
3GS	June 19, 2009

To put the argument that Garmin's misfortunes are due solely to Apple's iPhone to rest, one merely needs to compare the margin data with a timeline of Apple's iPhone. Garmin's margins have been declining, since before the first iPhone was even announced. It was not until the iPhone 3G was released in mid-2008 that decent navigation capabilities came to the iPhone and it was not until the 3GS that true turn-by-turn capabilities were possible. With the 3GS on the market for only three weeks and the simultaneous 3G price cut, it would appear that the worst is yet to come for Garmin's margins.

Fortunately Garmin has a very strong balance sheet. Liquidity is excellent, highlighted by a current ratio of 6.0 and a quick ratio of 4.5. However, long-term assets, specifically PP&E have been declining as capital expenditures are not increasing significantly. I will discuss the significance of this in more detail in the free-cash-flow analysis below but for now just take note that this is not a good sign for a growing company. On the other side of the balance sheet you see a company with no long-term debt. In fact, Garmin has three times more current assets than total liabilities ($1.8B versus $.5B), an impressive characteristic that I cannot remember witnessing in any other stock that I follow.

Garmin is currently yielding 3.2%, much higher than average for a growing technology company. Typically these high-growth companies reinvest earnings in operations so in this scenario, I consider Garmin’s high yield to be a red flag when the industry average is .4%. The dividend certainly appears to be safe with a payout ratio of 25 and strong free cash flows; however, I cannot fathom the dividend continuing to grow at anywhere near its historical growth rate (five-year dividend growth rate is over 30%).

(millions)	2008	2007	2006	2005
FCF	$675.4	$393.6	$229.3	$218.4

By paying out such a high dividend and using excess cash to repurchase shares, management appears to be signaling that the “supergrowth” days are over for Garmin. Rather than investing in R&D and expanding the potential market, Garmin is choosing to return value to shareholders. Ordinarily this is commendable but this will inevitably lead to a drop in analysts’ estimates; however, I temper this by noting that the PE is already a minuscule 7.5. On the other hand, GRMN is trading at a relatively expensive price-to-book greater than 2.0. Therefore, let the buyer beware.

In closing, there is no denying that Garmin is an efficient company that is focusing on increasing shareholder value. This is confirmed by the insiders and five percent owners holding a 44% stake in the company. I hope to give potential investors pause when trying to classify this as a classic growth or dividend play. This concern may be coming to fruition with the short percent of float at 13.3% as of June 10^th. With its hybrid status and lack of a clear classification, I am afraid that Garmin will be shunned by both groups of investors and ultimately succumb to the intense competition from its peers.

Sources: Motley Fool, New York Times, Wikipedia, and Yahoo Finance

Disclosures: I am long AAPL, GOOG, and RIMM.

Comments

[frugalandpu...:]

Good foresight, writings on the wall, but almost impossible to turn into a well TIMED short trade. I'll pass on this one.

Jul 14 09:33 AM

[inSearchOfV...:]

Very good analysis. Thanks for this article.

Jul 14 09:37 AM

[RWCMom:]

Paul, I didn't see any discussion of the other branches of their product line which cater to GPS specific industry needs: aviation, navigation, hunting, fishing, hiking/orienteering. Do militaries use their devices. Do they have good maps for less urban locals throughout the world? While the personal GPS/phone market may be compromised, it seems as though they have a lot more to offer which has not been thoroughly presented.

Jul 14 02:55 PM

[Paul Zimbardo:]

@frugalandpuzzled

Thanks for the complement. I realized when writing the article that there was nothing really to time on this one, thus it is not a great short target. As you so aptly put it, the “writing is on the wall” and I hope that potential investors take heed of my advice.

@inSearchOfValue

Thank you as well. I am glad to know that I aided you in some way. I will continue to post similar articles so stay tuned if you enjoy my style.

@RWCMom

Great questions and I will try my best to answer them.

Garmin operates primarily in four segments: Automotive/Mobile, Marine, Aviation, and Outdoor/Fitness. As of the first quarter 2009, automotive/mobile accounted for 59.5% of Garmin’s revenues and the next closest was outdoor/fitness at 18.3%. All segments shrank except for outdoor/fitness (this would include the hunting, fishing, hiking/orienteering which you mentioned) which grew by thirteen percent. In that regard outdoor/fitness was a bright-spot and presents a growth opportunity going forward. The reason why I did not explicitly discuss these other segments is twofold. First of all, at almost 60%, automotive/mobile is the primarily business line and the others are more of niche markets. Garmin’s core competencies lie within this segment and I would not be as confident if management were to shift the focus to one of the other segments. Lastly, the technology underlying all of the segments and products is the same. Therefore, if Garmin is displaced as a leader in automotive/mobile, it is only a matter of time before its earnings and cash flows dry up and it is unable to fund research and development to compete in the other segments.

As far as I know, Garmin does not have any significant military market.

In regards to the geography question, I can only tell you that the largest market is the United States (60.6% of revenue), followed by Europe (33%), and Asia (6.4%). Based upon this, I do not believe they focus on any “less urban locals”.

I did not mean to portray Garmin as a one-trick pony, but in my opinion, if its core business is compromised, its others will suffocate due to a lack of funding. Thanks again for the questions, I am happy to share my insights and help others.

Source: www8.garmin.com/compan...

Jul 14 09:55 PM

[nmelendez:]

I remember when they said the same about Apple. 10,000.00 USD of Apple bought in 2002 would be worth what today? I understand your concern about Garmin. The real problem is Garmin just buys out lines made by other companies and then outsource to China to build. When they start manafacturing locally and start the real integration i think GRMN will take off. They make the best ADS-B packages for GA and Micro jets. Plus their GPS tracking systems are starting to take hold. I believe Garmin still has to fall to 7 or 8 but in the long run it could end up being another apple. Heck if they do fall to 7 or 8 they could buy themselves out. They hold 1 billion in cash with zero debt.

Jul 14 11:07 PM

[Alex Jantsch:]

Paul,

Now while I understand the points you laid out, I do not agree that Garmin has lost the reins. We are not strictly talking about GPS for cars or handheld navigation alone. The range of products that Garmin produces expands well beyond what the iPhone or others can do. Even though they might be taking a bite out of Garmin's bread and butter products, they cannot take away from customers who are seeking something the iPhone can't offer (freshwater maps, saltwater maps, electronic compass, barometer, dog tracking systems, two way radios, golf handhelds, running and cycling, flying, and marine products to name a few). These products have patents, patents that can and will be enforced. I think you severely underestimate the wide array of things a GPS/Personal Navigation company can do. I agree that companies like Apple will continue to come out and eat away at their navigation capabilities with more and more technologically advanced applications but there is one aspect that they can't overcome, their apps are still combined with phones. Noone wants to go fishing, hiking, cycling, etc using the big bulky iphone compared to something that fits around their wrist or clips on their body. It would be a distraction and a hassle. Thats why people buy Garmin products because their phones aren't as activity friendly. It will take a long time for Apple to eat away at Garmin's market for items like their freshwater and seawater maps, their aviation capabilities, and their marine capabilities, etc. In the time they have before Apple is able to catch up on those things (if Jobs is even worrying himself with such innovation), the industry change will take place and the demand for GPS will become a more commodity than luxury. This means that GPS will be considerably more widespread in cars, and I don't think you can argue that. This is where Garmin comes in because they are the industry leader in Automotive GPS and personal navigation. They will have their products in a lot of cars in the future, that business is nothing of Apple's. Plus in some states it is illegal to use your phone while driving, and I do know someone who has gotten in trouble for using their iPhone maps while driving and I believe it will become increasingly more illegal due to texting in cars. So your arguement that the iPhone can supplement for Garmins main market in automobiles is futile in the long run because all Garmin has to do to make iPhones obsolete in the car market is to make deals with the auto companies and get their products made INTO the car and therefore not illegal to use in some states. The idea that the sky is the limit for Garmin is not preposterous. Their stock price went from over 100 to 20 in the course of this recession without any rational. The stock price beating was in no way justified for a company with no debt in a recession where debt laden companies are why we are in a recession. This is a good, market leading company in an industry that is about to change and you, nor the iPhone (unless is does something overly dramatic), can say anything against that. Garmin will recover and I will be extremely surprised if it doesn't reach 50. If you don't think so then thats fine, but just know that discounted cash flow analysis and free cash flow analysis don't always come out with the right numbers. There are things that have to be taken into consideration that those methods cannot do. So my DCF and FCF didn't say 50 was the price, but then I throw in the catalysts that they can't comprehend and this is where my assumption lies. Your analysis is acting like the company's common stock didnt just lose 80 percent of its value from its peak for no reason, because it did and thats how you have to look at it. Garmin will rise again, I am sure of it.

Jul 15 01:04 PM

[Paul Zimbardo:]

@Alex

As you can see from the segment breakdown I posted in response to RWCMom, smartphones are attacking the core of Garmin’s business. Apple does not need to offer capabilities to capture the marine and aviation markets to severely damage Garmin. By eroding the capital base and source of cash, Garmin will not be able to fund these niche segments. These segments do not generate enough revenue to even match the R&D expenses.

I got a nice laugh when you dismiss the iPhone as “big” and “bulky” but commend Garmin’s products for being “activity friendly”. For reference, the iPhone’s dimensions are 4.5 inches by 2.4 inches by 0.5 inch. In comparison, the Oregon 400T (the highest rated hand-held Garmin GPS on Amazon) has dimensions of 2.6 inches by 2.6 inches by 1.3 inches.

Garmin was overvalued at fifty and drastically overvalued over one-hundred. This is company facing increasing competition, shrinking margins, and selling a luxury product in a severe recession. If you still think Garmin fell for no reason, I suggest starting your research over again. The fact that you do not use DCF valuation leads me and other informed investors to dismiss your projections. DCF valuation is the way that we value equity on the street. The DCF is always right, just as arithmetic is always right. The assumptions may be wrong, but the method is sound. Any “catalyst” that you mention can be incorporated into the growth assumptions of cashflow forecasts.

Jul 15 10:26 PM

[Alex Jantsch:]

Paul,

Only time will tell. I never guaranteed to anyone that I was right, but I respectfully still believe that I am. You should choose another way to try and convince people that you are right. People are entitled to their opinions, but assuming I don't know what I am talking about is pretty ridiculous. It's not something that makes anyone want to listen to what someone has to say. We shall see what happens with Garmin, but its not something I'm going to argue with you about.

Jul 16 12:22 AM

[Alex Jantsch:]

by the way, where on "the street" do you work?

Jul 17 01:20 PM

[suec:]

I've invested in Garmin in the past. Probably won't now. But I checked the TelNav/AT&T app offering for iPhone as that sounded promising. People HATE it universally—say it doesn't work worth crap. And why pay another $10 per month on AT&T way overpriced monopolistic service charges, when Google maps works fine (without voice directions, but that's coming and it'll be free)? So Garmin may have a reprieve on the consumer market for at least a little longer. Plus, believe it or not, there are still people out there without smartphones. (In fact I still know folks without cell phones at all. Luddites all.)

Aug 05 02:45 PM

[SlipperyWing:]

"Lastly, the technology underlying all of the segments and products is the same."

This statement shows how completely naive you are, along with the rest of the world, on Garmin's aviation segment.

Do you have any idea what type of sensors go into the G1000 integrated cockpit? From AHRS attitude and acceleration data in one box, to pure airspeed and altitude data in another box, autopilot servos that trump any existing autopilot in the market, XM weather, a RADAR, engine indicating and crew alerting systems....

And you try to tell me that the underlying technology is the same across segments?

Get with the program jack, everyone seems to think GPS is the only thing Garmin has any experience in.

Nov 02 09:02 PM