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MagicDiligence (< 20)

Magic Formula Stock Review: Garmin (GRMN)



June 26, 2009 – Comments (0) | RELATED TICKERS: GRMN , AAPL , BBRY

It wasn't very long ago that Garmin was a popular stock with the growth investing set. Today, with an 21% earnings yield 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 4 segments. Automotive, which consists of in-dash or mounted units in vehicles, accounts for 59% of revenues, although only 8% of operating profits. The Outdoor/Fitness segment, consisting mainly of Garmin's handheld personal navigation devices (PNDs), contributes 18% of revenue and 49% of profits. The Aviation unit, which builds devices for use in aircraft cockpits, delivers 14% of sales and 25% of income. Lastly, the Marine unit, which produces positioning systems for water bound vessels, contributed 9% of sales and 18% of profits.

The GPS market a few years ago was a very fast grower - Garmin between 2004 and 2008 delivered impressive annualized growth of over 50% for both sales and profits. This growth was capitalized by the few dedicated providers of devices, most prominently Garmin and competitor TomTom. However, the competitive picture is vastly different today than it was even back in 2007. While the GPS market should still benefit from healthy growth (unit sales are predicted to triple 2008 levels in 3 years), there is voracious competition that will limit the profits for all. GPS is almost a commoditized feature in small consumer electronics now. Not only does Garmin compete with TomTom and Magellan, but also devices from big consumer electronics makers like Sony (SNE) and LG Electronics, as well as many bargain bin Asian electronics brands overseas. Perhaps most concerning is the trend towards GPS features in so-called "smartphones". The features and implementation in Apple's (AAPL) iPhone or Palm's (PALM) Pre are (or will soon be) virtually identical to the handheld or car mounted units produced by Garmin. Competition is most evident in gross margins, and here a very stark degradation can be seen:

Garmin's Gross Margin

TTM: 43.8%

2008: 44.5%

2007: 46%

2006: 49.7%

2005: 52.1%

2004: 53.9%

To combat these threats, Garmin has been developing its own entry into the phone space, the nüvifone. While MagicDiligence sees why the company would take this route, the chances for success are pretty slim, especially going up against established and popular competitors like the iPhone, Blackberry (RIMM), and now Palm and Google (GOOG) Android phones. Execution is also in question, as the nüvifone has already been pushed back almost a year now.

For these competitive reasons, MagicDiligence cannot recommend Garmin as a Top Buy. In fact, I don't recommend MFI investors consider Garmin as a holding. The future is just too cloudy here, the competition too strong.

It's too bad, too, because Garmin has a lot of good qualities. The company is very financially strong, with a huge cash chest of $940 million with no debt. It is one of the few high tech companies that pays a dividend, in fact a pretty substantial 3.4% yield at the time of this writing. Free cash flow margin has routinely come in above 20%, which is exceptional, and return on capital on both a normal (48%) and MFI basis (73%) remains excellent. Co-founder, CEO, and Chairman Min Kao owns a massive 22% of his company, and his executive bench is experienced and deep.

In any other, less competitive market, Garmin would be an easy recommendation. In the fast moving and highly competitive GPS market, however, today's valuation does not look unduly cheap.

Steve owns no position in any stocks discussed in this article.

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