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Sunday, October 22, 2017

Valuation: Garmin Ltd. (GRMN)


Company Profile:  GARMIN LTD. (GRMN)

“Garmin is a leading, worldwide provider of navigation, communications and information devices, most of which are enabled by Global Positioning System (“GPS”) technology.  Garmin designs, develops, manufactures and markets a diverse family of hand-held, portable and fixed-mount GPS-enabled products and other navigation, communications and information products for the automotive/mobile, outdoor/fitness, marine, and general aviation markets.” – Garmin 2007 Annual Report to Shareholders

Business and Management Review

1.        Is the business simple and understandable?

Yes the business seems to be simple and understandable.

 Garmin produces and sells navigation devices worldwide.  Garmin has a niche in four market segments in which it is a clear leader:  (1) Automotive , (2) Outdoor/ Fitness, (3) Marine,  (4)  Aviation. 

Garmin’s product line comes standard or optional on various models of automobiles, boats and aircraft.  In addition to personalized navigation devices, Garmin makes software applications for smartphones providing pre-loaded maps, traffic alerts and fuel prices.  Fitness products include GPS watches and personal training devices enabling work out tracking and two way navigation integrated radios.  Marine products include chart plotters and networking, autopilot systems, fishfinders and radar.  Garmin’s aviation products are also sold via distributors who have the ability for “at-airport installation.”  In addition to handheld / portable and panel-mounted aviation products, Garmin’s avionics have been expanded to leading manufacturers as well (Cessna , Raytheon, Piper, Diamond, Mooney, etc.)  Garmin sells to original equipment manufacturers to add as features on their products (i.e. Harley-Davidson, Toyota, Ford, BMW, Mazda, Hyundai, Chrysler, Honda, etc.)

Garmin’s vertically integrated business system can be easily understood in various segments.  Garmin manufactures its products in facilities located in North America (Olath, Kansas), Europe (Totton, Southampton, England) and it largest manufacturing facilities in Asia (LinKou, Taiwan).   Distribution and marketing are done regionally via the three aforementioned business centers , through a distribution network of roughly 3,000 independent dealers and distributors globally to 100 countries.   Garmin keeps its advertising in-house, thus enabling them to streamline costs while taking a more focused approach.

Garmin has developed a unique style that takes a systematic approach to R&D.  This helps them close the innovation gap with its competitors.   They have been able to do this by partnering their manufacturing and engineering teams, and integrating their product development teams in a multidisciplinary fashion to work on newly approved designs.  A focus of Garmin has been their ability to reduce R&D costs to net sales, while improving product rollout.

2.        Does the business have a consistent operating history?

Yes the business does seem to have a consistent operating history.

The company is the parent company of a group of companies founded in 1989 by Gary Burrell and Min Kao.  Combining their first names creates Gar-Min.  Their first products were introduced in 1991.  After a hugely successful introduction of their product line, Dr. Kao set up low cost manufacturing facilities in Taiwan.  Garmin Limited was incorporated in the Cayman Islands on July 24, 2000.  The company has enjoyed consistent revenue growth since then.  

3.       Does the company have favorable long term prospects?

 This company seems to have favorable long term prospects.

Unfortunately the economics of a business can be the most subjective part of any review.  Management runs a lean operation on zero debt. Their current ratio indicates they have the resources to meet expenses for four years.  Their Return On Investment Capital (ROIC), at 39%, puts them in league with Microsoft, Google, and See’s Candy Inc.   Garmin does not receive more than 10% of its income from any one distribution source.   All four market segments have seen growth.  Garmin leads among its competition in terms of Return on Assets, Gross Margin and Net Margin.   Garmin also is the market leader for GPS devices in all four of its market segments. This arrangement should be an indication of the company’s long term prospects.

Although Garmin has 28% of market share in its automotive business segment, quite a bit of concern in the media has been expressed regarding devices like cell phones and smartphones that offers GPS as a feature on their products.  What the markets are actually showing is that the GPS features tend to make consumers purchase dedicated GPS devices, not the other way around. 

Garmin’s competitive edge comes from their vertically integrated business system and manufacturing capability, allowing them greater flexibility as products roll out cradle to grave. This has provided them with reduced time to market, design and process optimization, and logistical agility.  According to the 2007 Garmin Annual Report:

“Garmin’s products are introduced to production at an early development stage and the feedback provided by manufacturing is incorporated into the design before mass production begins….Garmin uses its manufacturing resources to rapidly prototype design concepts, products and processes in order to achieve higher efficiency, lower cost and better value for customers. …Operating its own manufacturing facilities helps Garmin minimize problems, such as component shortages and long component lead times which are common in the electronics industry.”

Garmin’s international market share and product lines give it added strength by spreading out risk.  This makes Garmin a little less vulnerable to a recession than its peers.  Although not significan ($23 M gain), it’s important to note that Garmin gained income from favorable exhange rates as the US Dollar fell in value relative to the Euro, Taiwan Dollar and British Pound Sterling.  Garmin’s distribution, and local marketing/ adverstising strategy in multiple markets and geographic niches gives it a clear competitive advantage on a global scale.

Garmin’s flexibility afforded by its business model has allowed it to take a strong presence in Asia by being ahead of the market while introducing products that work via Chinese voice commands rolled out of its largest manufacturing facilities already located there.  According to the World Bank Group – International Monetary Fund, in three key market areas that are larger than Garmin’s current markets, China has begun construction on new infrastructure.  To accommodate a 20 fold increase in air traffic the past 20 years, China will add 97 new airports.  1000 new cars roll out on the streets of Beijing daily. 50,000 miles of high grade express way and 165,000 miles of rural highways are slated to be completed by the end of this year.  Rivers link cities all over China.  China is actively dredging major waterways, building inland ports and will upgrading port transit at 12 sea ports.  All of these expansion projections offer strong markets for Garmin to tap.  

Most Important:  A key measure of a company’s long term prospects is how it holds up during adverse economic conditions.   Garmin’s 2007 Annual Report clearly states:

“Our sales are subject to significant seasonal fluctuation.  Sales of our consumer products are generally significantly higher in the fourth quarter, due to increased demand for automotive/mobile products during the holiday buying season, and, to a lesser extent, the second quarter, due to an increased demand during the spring and summer marine season and the Father’s Day/ graduation buying season.”

The data clearly supports this, as the first quarter has been Garmin’s worst performing quarter since 2000.  The only exception has been 2003 when it was then their second to worst performing quarter.

 In spite of this, recent quarterly results reported for 1Q 08 were higher than 1Q 07.   This should not have been possible considering that 1Q 07 represented the height of the housing boom when consumers had the most disposable income.   This is a clear indication of Garmin’s ability to weather harsh market conditions and thus their long term prospects.

4.        Is management rational?

Management seems to be rational.

I have never personally met Dr. Kao, his management team, or his successor Cliff Pemble.   It’s difficult to make an objective assessment of management’s rational approach to business, even if we did meet.   Some important facts need mentioning though.  The founders of the company have the largest ownership stake.  Dr. Kao had 10,366,188 Shares as of Oct 07.  His income and his net worth are tied to Garmin’s fortunes.  He is also handing over the roles of President and CEO to Cliff Pemble.  He cannot afford to be irrational in this decision before he leaves to work aggressively to lead Garmin’s Asia-Pacific business development and sales initiatives.

This could be luck, but Garmin management seems to anticipate market movements with unusual dexterity.  For example they timed the introduction of the NuviFone around the I-Phone II and can adjust the design for market sentiment as quickly as Apple can.  Cell phones with GPS capability tend to increase interest in dedicated GPS systems, not the other way around.  Management pulled an advertising coup by being the first GPS company to advertise in the Super Bowl.  Soon after, Garmin exceeded TomTom in market share.    The company has aggressively expanded factory space in Taiwan a year before China announced its infrastructure expansion plans. 

On February 4, 2008 the board approved a share repurchase plan, which empowers management with the ability to take advantage of lower stock prices, and purchase 5M shares to add to shareholder value.  This flies against the grain of the “institutional imperative” according to Benjamin Graham.

5.       Is management candid with its shareholders?

There is no indication that management is not being candid with shareholders.  On a fundamental level, the 2008 Annual Report contains 138 pages detailing nearly every facet of the business, to include an appendix that contains the text of its employee stock purchase plan.  That last part seems unusual.  Garmin’s investor relations department has gone above and beyond expectations considering the size of its operations.

Financial and Value Review

Evaluation for the needs of the defensive investor:

1.        Size of firm:  Pass

          $10.22 Billion

2.         Strong financial condition:  Pass

          The company has 0 debt, and has a current ratio of 4.13

3.        Earnings stability:  Pass

          Garmin has had a consistently positive net income for over 10 years.

4.        Dividend record:  Fail

          Garmin has consistently paid a dividend for only 5 years.

5.        Earnings growth:  Pass

          Garmin’s earnings have grown more than 1/3 over the last 10 years.

6.       Price to Earnings Ratio:  Pass

          Using a weighted earnings at 2.389 and price today at 45.90, the P/E ratio is then 19.21.  

          Requirement under 20 is met.

7.        Price to Book Ratio:  Fail

           4.9

Garmin only passes 5 of the required 7 tests for the defensive investor.  Thus Garmin is not suitable for the defensive investor.

 Evaluation for the needs of the enterprising investor:

1.       Strong financial condition:  Pass

          The company’s current ratio is 4.1, and 0 Debt

2.        Earnings stability:  Pass

           The company has achieved a positive net income for over 5 years.

3.        Dividend record:  Pass

           The company currently pays a dividend.

4.        Earnings growth:  Pass

           Earnings are greater today than they were 5 years ago.

5.        Price:  Fail

           The price is not less than 150% of the net tangible assets.

Having passed 4 out of the 5 tests for the enterprising investor, I feel that Garmin is suitable for the enterprising investor.

Valuation:

Our valuation model puts fair value at $92.00 a share.

Opinion:

Since the company is currently trading at about $45.90, we feel using Benjamin Graham’s value analysis for weighted earnings, it is undervalued at the present time and within a good margin of safety.

One reason the company may be undervalued is a consensus among the media, and over half the analysts covering Garmin, that the company’s inventory and demand for its products will decline as they come under price pressure.  Some anticipate that future sales will decrease and revenue will decline in Q2.  In contrast, Garmin’s management believes that growth in sales of automobile products is,

“due to overall increase in consumer awareness of the capabilities and applications of GPS, particularly those capabilities pertain to automobile navigation.”

 Therefore these analysts seem to be at odds with management in their assessment of Garmin’s future growth prospects.

My concern with using differential equations to measure the relative strength of the economy against inflections points and rates of change in revenue and inventory levels is the following:

The mathematics used for these calculations were invented for the sole purpose of finding out how far a bowling ball will traverse after you kick it off a cliff.  No offense to Isaac Newton, the earth and the ball are pretty predictable.  Differential equations are useless in measuring chaotic markets or the weather, except in pre-defined ranges.   Edward Lorenz proved you can’t predict when a butterfly flapping its wings will cause hurricanes in the Gulf of Mexico or Garmin’s stock price to drop.  The only exception to this rule is if your stock analyst is Miss Cleo.  In all fairness to Miss Cleo, most academic studies have shown that she would likely be nearly as accurate as the results provided by most available models on Wall Street.  

The equations used are the exact same ones used to calculate the path of a roller coaster car. The only difference is that when you apply them to the stock market you tell the mathematician, the track layout is a mystery.  Take your best guess as to where the car will end up next month.   It then becomes a question based on price and not the value of the company.  This makes no common sense at all.  So why does everyone line up behind the calculus?  

In light of this, I decided to create my own mathematical model to analyze Garmin’s potential margin issues under the harshest set of economic conditions imaginable.  Anything less would be irresponsible….

The name for this mathematical model is:  Mars Attacks 101

Our first assumption is that Martians invade, land on earth and then zap everyone’s automobile GPS.  Our new masters institute laws preventing anyone from manufacturing an automobile GPS in the future.   What would Garmin look like now?  First off, the company could make payroll for 4 years, assuming the ensuing conflict would not cause skyrocketing inflation.   We can extrapolate from the balance sheets that Garmin would make a healthy $322,963,000 per year from its other businesses!   That is per share earnings of 1.47 with a growth rate of 17% for the remaining three segments of the product line.  Then we can discount for cash flows and analyze:  If Martians invade planet earth, Garmin is worth $42 a share  – about what it’s trading for now.   Also, why are we concerned about inventory pricing models, when they dominate 28% of the automotive market share that doubled from 06 to 07?  Their revenues in this area keep on growing.  It’s a non-issue.  

*( Please reference Pages 44-48, 55, and Note 11 of the 2007 Garmin Annual Report for the numbers used for this extrapolation and assessment.)

It’s important to note that as of this writing, Garmin had 62 positions advertised for hire on their web site, over 50 of them in North America.  If management is expecting a slow down, why are they aggressively hiring? 

 With zero debt, a current ratio over 4, increasingly greater earnings, and a relatively high return on investment capital, the leanest operation among its peers, the largest market share, and expanding markets, then why is this company priced at nearly 1/3 the price it was valued at by the market this time last year?  Garmin has dropped in price just as quickly as Sprint.  The difference is that Sprint is losing more and more money, while Garmin is making more and more money.   I don’t have the answers to this, but the current financial condition of the company is what prompted me to write this up. 

What is your opinion?  Do you agree or disagree?  How do you feel about Garmin?  Please let us know by leaving a comment. The author did have a position in Garmin at the time of publication.  Also, please read our disclaimer and Our Methods.

5 Responses “Valuation: Garmin Ltd. (GRMN)”

  1. Andrew in Doddsville
    May 25, 2008 at 11:38 pm

    I was wondering if your assessment of earnings over X period in some way accounts for inflation. Is your assessment in current dollars and how did Graham address this issue.

    Thanks.

    Andrew in Doddsville

  2. buffetteer17
    May 28, 2008 at 4:25 pm

    I started value investing in late 2004. I did well in Garmin holding shares and LEAPs for roughly a double between mid 2006 and mid 2007. My fair value estimate was $95 and my purchases were below $47. I sold 2/3 but was too greedy to sell all.

    Now I’m back with 15% of my portfolio in Garmin stock and LEAPs. I figure fair value is around $100, based on DCF. Perhaps a little less if there is a significant slowdown in GPS sales during 2008. I figure such a slowdown will delay some sales, but not eliminate them.

  3. ben d.
    May 29, 2008 at 6:25 am

    Aaron, loved reading this, I am not currently an investor in the company but have been follwing them for a few years now… in fact some due diligence on them a few years ago motivated me to get into a similar business. The things that impressed me the most about the company besides a very solid balance sheet and what I thought was great growth prospects, was the fact that their products worked very well and were truly very valuable to me as a consumer. I also was impressed by management, and felt that they were quite shrewd and forthcoming in the way they ran the company. I too am baffled by the recent downturn and think I’ll be buying again soon.

  4. tech-challenged
    June 13, 2008 at 7:09 am

    I clicked on this link because I am considering GRMN as a short, but you had some good arguments. What are your thoughts on the replicability of their various technologies? Is what they do so special and hard to copy that other enterprising technology companies cannot enter the market, depressing ROICs?

    Thanks for the interesting write-up.

  5. AaronH
    June 22, 2008 at 9:45 pm

    I apologize for the late response since I have mostly been gone. The concerns you express regarding replicability are well founded. It almost prompted me not to write this up. Can other enterprising companies enter the market and depress ROIC? Possibly. I am not a professional analyst, electrical engineer or patent attorney, so I can’t answer this honestly. Even if I was, lacking a crystal ball, it would be impossible to give you an accurate answer. Anyone that claims to provide a definitive answer would be lying.

    In order to remain within the scope and context of the site, the long term prospects of the company are answered in question three. I also took a jab with the Mars Attacks analysis in the opinion section.

    A lot of that analysis can be simplified this way. I can make a better hamburger in my kitchen than Wendy’s, McDonalds, Burger King and Whataburger. It’s simply impossible for me to sell as many since they have a superior business system in place that would beat me hands down as their competition. Garmin is the leader now. Since they have three other profitable business units, where they possess a clear long term competitive advantage, why are they priced as if they just came in dead last selling personal navigation devices?

    Respectfully ,
    Aaron

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