A Contrarian's View on Garmin

Barrons over the weekend issued an upbeat note on Garmin (GRMN), indicating that the stock has much more room to run from current levels. However, I believe Garmin on Aug 1, 2007 is going to issue guidance that will be reflective of declining gross margins for its PND business due to change in product mix, increased competition and prospect of flat to rising component costs for at least the remainder of 2007.

The Street is pricing in a solid earnings report for Q2 and positive color on forward guidance. The bull story with Garmin is the sustainability of its gross margins, specifically as relates to its PND segment. There is no question that the automotive market for PND is highly under-penetrated and represents a tremendous growth opportunity.

However, there is a sense of conviction floating around that Garmin can be the Apple of the GPS market,and will not compete on price but on brand equity and core functionality around its product, in other words, that its gross margins are likely to be immune from price cutting carried out by its competitors. How true that conviction is will hopefully come to light when the Company announces results for Q2.

I am of the opinion that the proliferation of low end GPS devices that carry the same core functionality as those of the low to mid end Garmin product line will cause the Company to lower prices in order to drive incremental unit sales. Also, there will be a shift in Garmin’s product mix as more sales will be driven off lower priced products such as the Nuvi 200, retailing around $275 on Amazon.

Additionally, we have seen a rebound in NAND flash pricing as well as an uptick in LCD panel pricing, both of which were in free fall until a few months ago, which provided the much needed cushion for Garmin to maintain its margins. The stock has had a solid run over the last few months and is off a mere 2.3% from its all-time high reached on July 26, 2007.

Obviously, the Street has priced Garmin to perfection and I am pretty certain that there is money to be made on the short side of the trade. Note that my call here is purely short-term in nature and I am not even going to consider the longer term threat of in-dash systems and the more timely threat of GPS service being offered by wireless devices such as cell-phones.

Additionally, I just cannot help but ponder about the valuation gap that exists between TomTom and Garmin. TomTom which is a pure-play on the PND market trades at 10.6x 2007 consensus EBITDA and 9.2x 2008 consensus EBITDA. Garmin in contrast trades at 23.6x and 20.8x current street consensus EBITDA respectively. Granted that Garmin has a more diversified portfolio comprised of auto, marine, aviation and outdoor fitness compared with TomTom which is purely focused on the automotive market. Granted also that Garmin has been more aggressive with its R&D and IP protection than TomTom has been, but such a huge valuation gap cannot be justified in my mind.

Let us not forget that TomTom is the clear leader in the global GPS market with a top presence in Europe. I am a big fan of Garmin management and greatly believe that they been nothing short of phenomenal over the last couple of years. My opinion here is not reflective in any way of management’s quality and its ability to execute according to plan but more on Wall Street getting ahead of itself. My thesis may be completely off, and Garmin may end up providing stellar guidance around gross margins and unit growth for the remainder of 2007 which might propel the stock to stratospheric levels.

However, if I were to be a speculating individual, who I am, I would be more inclined to go long TomTom at current levels and short Garmin into the second half of 2007.

Disclosure: none

Comments

[Tom B:]

If Apple adds GPS to the iPhone, Garmin is deceased. Garmin is a one-trick pony, and, worse yet, GPS's are sufficiently complex and inconvenient that UNLESS Apple or another smart company does one, most people will never one one.

2007 Jul 31 08:34 AM

[spbigger:]

I usually do not read articles that have no disclosure or identification of the writer. In fact, I usually just ignore them. I made an exception this morning because I have stock in GRMN and NVT and expect to buy more of each today.

The undisclosed writer may be onto something but I don't think the current competition will play much of a role,overall, for quite a while. Garmin will continue coming out with new units produced for different interests and I believe they will play some role in the developments leading up to phone-capability.

It seems to usually boil down to the money and in Garmin's case, I think it boils down to superior management and marketing in comparison to TOMTOM. However, I believe the mapping system of Tele Atlas is superior to that of Navteq in Europe as well as in the USA. Garmin,to me, has the superior hardware. If TomTom could match Garmin with unit quality, they would be a real force here in the USA. Both companies could stand improvement in the Customer Service areas.

I believe,too, that it will be quite a while before other mapping companies or unit producers can compete.

Sam Bigger in Townville, SC

2007 Jul 31 09:51 AM

[Tom B:]

I think you are probably safe for 12 months or so. After that--who knows?

2007 Jul 31 10:02 AM

[krautie11:]

oops

2007 Aug 03 12:54 AM

[spbigger:]

Response to comments of Thomas Barta,

I agree with you on being "safe" for about telve months. I do not agree with the part of GRMN being dead in the water if the phone capability develops. Interest in those should be great but I don't see a significant percentage of folks being interested for quite a while. Older folks,like me, will most likely continue preference for the portable devices due to screen size, limitations of vision, etc.

Eitehr way, GMRN and NVT are currently being mentioned in the same breath and I think it will continue--at least for a year or so when the regular evaluation should get real serious. A buy out of or by either company might alter the prosepects.

Sam Bigger in Anderson, SC

2007 Aug 03 07:43 AM