Garmin at 'Neutral' Over Stiff Competition, Despite 4.6% Dividend
February 16, 2011
Just a few years ago, Garmin (GRMN) was a popular stock with the growth investing set. Today, with an 14.6% earnings yield (8.9 P/E) and a place in the Magic Formula Investing screen, the company is firmly in value stock territory. What happened to bring this rocket stock back to earth, and have investors overreacted?
For those unfamiliar, Garmin is one of the leading manufacturers of global positioning system (GPS) devices worldwide. The company sells products in four segments. The largest is Automotive/Mobile, contributing about 60% of revenue and 38% of operating profits. The Automotive side consists of mounted or in-dash navigation and multi-function devices for vehicles, often factory-installed by manufacturers. The Mobile side is mainly Garmin's line of "nuvi" branded handheld personal navigation devices (PND).
Outdoor/Fitness is the second largest segment (21% of sales, 37% of profits). In this division, Garmin focuses on products that use GPS technology to help runners, hikers, cyclists, and even golfers better track their progress and performance. For example, the Forerunner fitness line consists of watch-style devices that use GPS data to determine a runner's distance and time, allowing calculation of such things as calories burned, miles covered, average pace, and so forth.
The other two segments, Aviation (10% of sales, 12% of profits) and Marine (9%; 13%), are pretty self-explanatory. While these two are the smallest contributors, they are also the areas where Garmin has the greatest competitive advantages, with a long history of supplying both industries.
Between 2004 and 2008, Garmin was a growth stock, with annualized growth of 50% for both revenues and earnings. However, the competitive picture is vastly different today. While the GPS market should still benefit from healthy growth, there is now voracious competition that has effectively turned the industry into a commodity and will limit the profits for all. Not only does Garmin compete directly with TomTom (TMOAF.PK) and Magellan, but also devices from big consumer electronics makers like Sony (SNE) and LG Electronics (LGERF.PK), as well as many bargain bin Asian electronics brands overseas. Low-end competition has crippled margins in automotive, and Garmin is facing emerging competition in its popular fitness products, with sports giant Nike (NKE) recently partnering with TomTom.
Clearly, however, the biggest threat is from smart-phones that contain GPS chips and can run low-cost, even free, software that gets very close to the functionality of Garmin devices. Take just the iPhone, for example. The built-in maps program does a credible job of imitating a handheld PND device. Automotive turn-by-turn apps exist from TomTom, MotionX, and others. GPS-enabled fitness apps like RunKeeper provide the functionality of Forerunner devices. That is all in one unit that a person usually carries around anyway, and all of these apps can be had for vastly lower prices.
Garmin tried to play in the smart-phone arena with the nuviphone and, quite frankly, got demolished. They killed the project last fall.
I don't want to sound hostile against the firm. Garmin has a lot of good qualities, too. Management is outstanding. Co-founder, CEO, and Chairman Min Kao owns a massive stake in his company (insiders own over 40%), and his executive bench is experienced and deep. Impressively, Garmin has managed to turn gross margins back up near 50%, after a slippery slide from the mid-50's to 44% in 2008. The firm is exceptionally healthy, with over $1.2 billion in cash and no debt. Free cash flow is strong.
One highlight of this stock is its dividend. The company pays a 4.6% dividend yield, and even that represents just 56% of free cash flow. Stock buybacks are common too, with shares outstanding falling by almost 4% annually over the past 3 years.
So what is the stock worth? It is difficult to model much growth for Garmin going forward. Sales declined 16% last year, are on pace to decline another 8% this year. Analysts predict further drops in the years ahead. No matter how well-managed, Garmin is still in a shark tank of powerful competition. Modeling near-term sales declines, and assuming more or less permanently lower valuations, Garmin looks to be worth about $31 to me - just slightly below current trading value. As such, I'm putting a "neutral" opinion on the stock. Magic Formula investors may want to look elsewhere for their next position.