NOTE: I had some difficulty with the formatting of this article. If you have any trouble reading the text here scroll to the bottom and I have embedded this entire article in scribd.
|Market Cap (millions)||$ 5,410.00|
|Current Price||$ 27.82|
|Shares outstanding (millions)||194.60|
Business Overview and Valuation
Garmin Ltd., together with its subsidiaries, designs, develops, manufactures, and markets global positioning system (GPS) enabled products and other navigation, communication, and information products worldwide. It operates in four segments: Automotive/Mobile, Outdoor/Fitness, Marine, and Aviation.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
The automotive/mobile sector brings in the largest amount of the company’s revenue making up 69.7%. Outdoor/fitness, Aviation, and Marine make up 15.9%, 6.0%, and 8.4% of the company’s revenue respectively.
The Outdoor/fitness segment mostly consists of Personal network devices (PNDS) that are used for navigation in cars. Sometimes, Garmin sells the GPS devices for use in high end automobiles to the car manufacturer directly, and to customers who want a detachable device. Company also produces navigation devices for motorcycles, Garmin is constantly coming up with new and updated GPS systems and aggressively expanding its presence overseas.
The company is the worldwide leader in GPS technology. There is no data available on market share by segment, but Garmin holds 36% of the global GPS market share, followed by TomTom. TomTom a UK based GPS maker, is Garmin’s largest competitor and holds 45% of the European market share, and 24% of the North American market share.
Below are some valuation metrics of the company:
|EV / OCF(ttm)||4.6|
|EV / FCF (ttm)||4.9|
|EV / EBITDA (TTM)||4.6|
According to almost all these metrics (with the exception of P/B) the company is very undervalued. I will state what I believe the intrinsic value towards the end of the article. However, there are aspects of the company that I believe is causing the market to severely underestimate the true value of the company which must be examined first.
Most analysts are obsessed with the spread of smart phones and the possible negative effect it will have on Garmin’s profitability in the automotive/outdoor sector. This is the main reason why I believe the stock is so mispriced by the market. The bears argue that the smart phones are a threat to the automotive/outdoor segment which is the largest chunk of Garmin’s revenues.
However, these analysts neglect the fact that the three other divisions have even higher profit margins than the automotive sector, and that Garmin dominates these areas.
December 26, 2009
December 27, 2008
|Year over Year|
|Gross Profit||% of Revenues||Gross Profit||% of Revenues||$ Change||% Change|
There has been reasonable organic growth in the three industries over the past several years.
As can be seen from the chart above, while the extremely impressive revenue increases have come from the automotive sector, the three other segments have produced satisfactory growth. Outdoor/fitness has grown by 250%, Marine has increased by 30%, Aviation 12% (excluding 2009 the number would be 44%).
The main growth has come from the automotive sector, but the marine and aviation sectors have had decent growth, and the outdoor sector has demonstrated phenomenal growth.
Data from the latest quarterly filling reveal that this growth has continued. Outdoor, Aviation, and Marine revenue have increased 28%, 9%, and 12% respectively.
Garmin’s main revenues come from Europe, and North America. However, the company is starting to make inroads into Asia. Revenue was up 54% YOY.
The analysts also neglect to realize that despite the massive growth of smart phones, Garmin has continued to be a dominate player in PND market. Blackberries, Iphones and other devices have become very popular over the past few years and yet from 2008 to 2009, Garmin’s market share of the GPS market has rose from 34 to 36%. Garmin’s gross margin of 52.3% in 2009 is actually higher than gross margins were in 2006. This demonstrates that the company has not lost its edge despite the large growth in smart phones over that time frame. This trend is likely to continue in the future. The reason for the growth of the PND sector is the fact that most people will not use their phone to navigate while they drive (they highly prefer a PND). Below are two charts showing the complete lack of correlation between Garmin’s revenues, and the use of smart phones.
|Year||Sales||Op Inc||Net Inc||EPS||OCF||Cap-Ex||FCF||DPS||Shares|
|2000||$ 345.74||$ 129.29||$ 105.66||$ 0.53||$ 88.32||$ (24.82)||$ 63.50||$ 0.15||199.36|
|2001||$ 369.12||$ 131.29||$ 113.45||$ 0.53||$ 129.99||$ (14.88)||$ 115.11||$ –||214.05|
|2002||$ 465.14||$ 177.44||$ 142.80||$ 0.66||$ 175.41||$ (12.42)||$ 162.98||$ –||216.36|
|2003||$ 572.99||$ 227.00||$ 178.63||$ 0.82||$ 175.18||$ (32.77)||$ 142.41||$ 0.25||217.85|
|2004||$ 762.55||$ 270.67||$ 205.70||$ 0.95||$ 208.94||$ (78.15)||$ 130.79||$ 0.25||216.53|
|2005||$ 1,027.77||$ 338.17||$ 311.22||$ 1.43||$ 247.01||$ (27.13)||$ 219.88||$ 0.25||217.64|
|2006||$ 1,774.00||$ 554.56||$ 514.12||$ 2.35||$ 361.86||$ (96.02)||$ 265.83||$ 0.50||218.78|
|2007||$ 3,180.32||$ 907.35||$ 855.01||$ 3.89||$ 682.09||$ (159.70)||$ 522.39||$ 0.75||219.80|
|2008||$ 3,494.08||$ 862.02||$ 732.85||$ 3.48||$ 862.16||$ (126.59)||$ 735.57||$ 0.72||210.59|
|2009||$ 2,946.44||$ 786.01||$ 703.95||$ 3.50||$ 1,094.46||$ (56.77)||$ 1,037.68||$ 0.75||201.13|
After reviewing the overreaction of the analysts it is important to realize that Garmin is no cigar butt stock. I am very conservative with valuation metrics, but Garmin clearly dominates its industry. This should cause the stock to demand a higher multiple than other companies. Below are some statics comparing Garmin’s to competitors:
|GRMN||Industry Average||Industry Percentile|
|Gross Margin (Most Recent Quarter, Annualized)||55.55%||28.12%||95th|
|Gross Margin (TTM)||52.53%||27.60%||93rd|
|EBITD Margin (TTM)||29.04%||10.54%||98th|
|Profit Margin (Most Recent Quarter, Annualized)||18.50%||4.19%||98th|
|Operating Margin (Most Recent Quarter, Annualized)||27.72%||7.44%||98th|
|Operating Margin (TTM)||27.14%||6.12%||98th|
|Pretax Margin (Most Recent Quarter, Annualized)||22.56%||5.83%||98th|
|Pretax Margin (TTM)||25.29%||2.97%||98th|
The after tax margins (which are not shown in the above chart) are also quite impressive. Garmin has a much lower tax rate. The effective tax rate for the past several quarters has been approximately 19%, compared to the US corporate tax rate of 18%.
I normally do not use DCF as a measurement of a stock’s intrinsic value; however using DCF with Garmin shows how cheap the stock is. I used a FCF growth rate of 3% for the next ten years, followed by a terminal rate of 2%. The discount rate used was 12%. The calculation reveals that assuming minimal growth over the next ten years Garmin’s fair value is $53.60. This provides the stock with a 29% margin of safety based on today’s price of 27.82. This is an extremely conservative estimate. Under every scenario shown below the stock is undervalued.
|Growth Rates||-1%||$ 50.27||$ 47.37||$ 44.77||$ 42.44||$ 40.33|
|1%||$ 55.25||$ 51.92||$ 48.94||$ 46.27||$ 43.86|
|3%||$ 60.84||$ 57.01||$ 53.60||$ 50.54||$ 47.79|
|5%||$ 67.10||$ 62.72||$ 58.81||$ 55.31||$ 52.17|
|7%||$ 74.12||$ 69.10||$ 64.63||$ 60.63||$ 57.05|
Using a reverse DCF shows the current stock price to assume approximately a negative 13% growth over the next ten years. This is highly unlikely, and it demonstrates the huge mispricing of Garmin by the market.
|Growth Rates||-17%||$ 25.36||$ 24.47||$ 23.65||$ 22.91||$ 22.23|
|-15%||$ 27.30||$ 26.27||$ 25.34||$ 24.48||$ 23.70|
|-13%||$ 29.46||$ 28.28||$ 27.21||$ 26.23||$ 25.33|
|-11%||$ 31.89||$ 30.52||$ 29.29||$ 28.17||$ 27.14|
|-9%||$ 34.60||$ 33.03||$ 31.61||$ 30.32||$ 29.15|
Some of the growth aspects were discussed above. However, some expansion is necessary. One very positive aspect of the company’s growth is the fact that it is mostly organic. From time to time the company will make small acquisitions, however Garmin mostly relies on itself to produce growth. This is a very important aspect that I look for in all companies.
FCF in the past has grown at a phenomenal rate in the past.
|Free Cash Flow|
|5 yr FCF Growth||54.0%|
|10 yr FCF Growth||30.3%|
In the DCF calculation used above I assumed scenarios of both negative growth, and low growth. However, if Garmin grows as it did in the past the stock can easily be worth many times the current share price. It is highly unlikely that Garmin will be able to grow at these rates in the future.
Analysts are predicting 5% EPS growth per annum over the next five years. If Garmin is able to achieve this lowball figure using DCF the company is worth $58.81.
Management operates in a shareholder friendly manner. Insiders hold 54% of the company’s stock. In a microcap company this might not be a big deal, but for a company with a market cap of over $5 billion this is a staggering figure.
Cash is used mostly for share buybacks and dividends. The annual dividend was just increased from $0.75 to $1.50. This gives the stock a dividend yield of 5.4%. Management has bought back many shares in the past several years, and recently announced another buyback earlier this year.
In addition, management produced a 25% return on equity over the past year. This occurred during the worst recession in 70 years. This number demonstrates that management is running the company very well.
Garmin has a very strong balance sheet. The company has zero long term debt, and plenty of cash. With over a billion dollars in cash, approximately 20% of the company’s market cap consists of cash. Garmin has a quick ratio of 4.1, and a current ratio of 5. In addition, the company does not require a lot of cash to operate. This allows the company to deploy cash for strategic acquisitions, share buybacks, and dividends (as discussed above). OCF was $1.1 billion in 2009 and CapEx was only $50MM. Garmin does not need to spend a lot on CapEx to produce high OCF and this means the company runs on a cheap, and efficient basis.
It is hard to determine the exact nature of the moat of the company, however there definitely is somewhat of a moat present. Below is some data to support this fact:
|GRMN||Industry Average||Industry Percentile|
|Return on Sales (Most Recent Quarter, Annualized)||18.50%||4.19%||98th|
|Return on Sales (TTM)||22.19%||2.50%||98th|
|Return on Equity (Most Recent Quarter, Annualized)||20.34%||11.69%||79th|
|Return on Equity (TTM)||25.12%||6.48%||83rd|
|Return on Assets (Most Recent Quarter, Annualized)||15.72%||3.75%||92nd|
|Return on Assets (TTM)||18.59%||2.61%||98th|
|Return on Investment (Most Recent Quarter, Annualized)||20.27%||5.79%||91st|
|Return on Investment (TTM)||25.03%||3.92%||94th|
The numbers here are quite impressive. The return on assets number is what I consider the most important. A company that is able to earn such a high ROA demonstrates that it has a moat. If it did not, competitors would come in and drive down the number towards an average return. For the past 5 years Garmin has averaged an ROA of 23%.
What gives Garmin its moat? It surely is not captive customers. It is relatively easy to switch to another GPS provider such as TomTom. I consider captive customers to be one of the most important types of moats. However, the company being the largest GPS manufacturer in the world benefits from economies of scale. This lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. In addition, the company has over 400 patents and 250 trademark registrations.
Finally, I look at my check list of several factors to determine whether Garmin is a good buy.
Valuation– Extremely undervalued assuming no growth, based on numerous valuation metrics
Growth– the Company seems poised to generate moderate to high growth in the future
Management– Management seems shareholder friendly with constant share buybacks, and dividend increases. Management has a huge state in the company.
Financial Strength– the Company has no long term debt, a quick ratio of 4.1, and a current ratio of 5.
Moat- The Company’s high returns on assets demonstrate the company has at least a weak moat. This is likely due to economies of scale, and patents on priopitery technology
The stock is a buy. The intrinsic value is approximately $45.5 per share using a TTM EPS of $3.50 with a conservative multiple of 13. There are a lot of valuation metrics that could be used to place the company at an even higher price, but P/E TTM is one of the metrics I utilize the most.
There are risks associated with Garmin. My main concerns are listed below:
Satellite technology for GPS devices is provided by the US military for free. Garmin has no contract with the Department of Defense and this arrangement could change any day. In such a scenario Garmin would have to find someone else (likely at a high price) to provide the company with satellite imagery, since the company has no expertise in the area.
Mobile phones equipped with GPS could threaten revenue in the automotive/outdoor, and fitness division (as discussed at length above).
Currency- the Company operates in different countries, and in different currencies. Garmin does not hedge its currency exposure, and any massive swings in exchange rates could hurt profitability.
Garmin has a very low tax rate since it is incorporated outside the US. There is a possibility that regardless of this fact Garmin will be required to pay US corporate tax rates (which are almost double the current rate the company pays).
Revenue is for the most part not recurring.
Any further decline in the consumer spending will obviously hurt the company.
Disclosure: Long Garmin