We are downgrading shares of Garmin Ltd (GRMN) to Underperform, since conditions in the portable navigation device ("PND") market continue to deteriorate.
Garmin generated around 64% of its third quarter revenue from the auto/mobile segment, the bulk of which comes from PNDs. Segment revenues dropped to around $442 million in the last quarter from around $627 million in the September quarter of 2008.
The main reason for the weakness is cannibalization by smartphones, as consumers are naturally attracted by the prospect of carrying a single device that would integrate the navigation and communication functions.
Recent market research shows that the next phase of growth in navigation devices will be driven by cell phones. Cannibalization was always expected and Garmin too expected it. It therefore launched its own version of a smartphone, which was referred to as the nuviphone.
But this is where Garmin made its biggest mistake. The smartphone market is crowded with the likes of Apple (AAPL), Nokia (NOK) and Research In Motion (RIMM) among others. It is therefore extremely competitive and the going was rough for a small company like Garmin.
Too late, Garmin withdrew its phone and instead decided to go along in the footsteps of archrival TomTom. In line with this strategy, the company is now making apps for the smartphone market.
PNDs are also reaching a saturation point in the developed markets of North America and Europe. Garmin has now decided to pursue growth in the emerging markets of Asia and South America, where the chances of success with a premium-priced product will be limited.
If Garmin decides to take market share in these regions, it will have to lower prices, which will have the inevitable negative impact on margins. This is the main reason we are taking down our estimates for the fourth quarter.
One option for Garmin would have been development of the in-dash business. But here too the company appears to have been napping. Although management continues to assure us that Garmin is building its in-dash business, it is evident that this was like an afterthought, so it now has some serious contenders.
Still, we think Garmin will make inroads in the U.S., since the brand is already recognized and popular here. The fact that auto manufacturing has largely shifted to countries where the Garmin brand is not as well-known could be a challenge, especially since other PND manufacturers will price their products competitively.
Surveys at Garmin’s biggest customers (stores) indicate that TomTom is continuing to price its products aggressively. However, while in the past, Garmin’s superior quality products enabled it to maintain market share despite its premium pricing, it is expected that this time round the market will respond differently.
The change in consumer sentiment is coming from weaker consumer purchasing power as a result of the recession, as well as the availability of navigation on smartphones. iSuppli expects all smartphones to incorporate GPS by 2011, indicating that the negative pressure will continue.
Given the problems Garmin is seeing in its core PND business, our earnings growth expectation for the company has dropped to an average of 8.8% over the next five years. We therefore believe there is further downside to the shares.
Garmin shares carry a Zacks #3 Rank, implying a short term (1-3 months) Hold recommendation.