Garmin's Got It

Sometimes the best investments are literally right under your nose, whether it's a Starbucks (Nasdaq: SBUX  ) coffee or a global positioning satellite (GPS) device made by world leader Garmin International (Nasdaq: GRMN  ) .

Garmin, which has a U.S. office and a factory in Kansas, has been an outstanding grower, increasing sales and net income at compounded annual growth rates (CAGR) of 23% and 36%, respectively, in the last seven years. Profitable since launching its first product in 1991, the company has been throwing off ever-greater amounts of free cash flow as it grows -- $160 million last year and likely closer to $200 million this year.

Garmin's incredible 40% operating margins and 32% net profit margins have helped it balloon its cash and investment hoard to $525 million (alongside zero debt), putting it in an even stronger industry-leading position. The company is able to acquire new technologies or competitors -- as it did this summer when it bought aviation GPS firm UPS Aviation, a division of UPS (NYSE: UPS  ) -- while still having plenty of cash for research and development.

Management is confident enough of its stellar balance sheet and free cash flow that it announced a new $0.50-per-share annual dividend this summer, giving the stock a yield of 1.5% at the time. While that isn't high enough to attract the attention of Motley Fool's Income Investor, the dividend is a nice bonus on top of the firm's 20%-plus earnings-per-share growth, and a yield usually helps put a price floor beneath a stock, too.

Room to grow
Garmin shares have gained more than 50% this year, and doubled since late 2002, but with GPS devices at market penetration rates comparable to those of cell phones in the early 1990s, plenty of room for growth remains. While GPS device sales won't grow as quickly as cell phones did, Garmin has a big lead in market share, so even modest increases in adoption rates will benefit the company a great deal.

And new products promise to lead to increased consumer sales. The company recently released the first handheld Palm (Nasdaq: PALM  ) operating system device to include GPS technology, called the Garmin iQue3600. Additionally, as it becomes more affordable, GPS technology promises to become a "no brainer" feature in automobiles and recreational vehicles of all kinds, the way GPS already is in airplanes and boats.

Garmin has the top brand in the business, leads every field it has entered, and has the advantage of manufacturing its own products, allowing for speedier adaptation of new technology and refined engineering (its facilities allow it to refine products along the way, even soon before launching mass production).

All this and its financial strength position Garmin to lead GPS technology devices toward mass-market status in the coming years. In much the same way that so many of us own computers and cell phones, a majority will eventually have a GPS device, too, typically for cars, but also quite possibly combined with cell phones and PDAs. Because what's more essential than needing to know where you are and where you're going?

Situation overview
With most small planes in America equipped with Garmin technology, aviation products account for about 20% of Garmin's sales, while consumer-product sales -- which are steadily growing -- account for the majority. To date, most consumer sales have been GPS devices for boats, fish finders, dash-mounted GPS devices for cars (with related mapping software), communication devices, and GPS systems used by the likes of the military.

In fact, the Department of Defense maintains and pays for the collection of satellites that makes GPS technology work (and work with incredible accuracy). Garmin and other companies are allowed to use the satellites free of charge, increasing prospects for competition, but also increasing Garmin's high-altitude margins.

In the second quarter ended June 30, the company's gross margin rose to 58%, up from 55% the year before. Net profit margin hit a record 32.8% (simply outstanding), up from 26% a year earlier. Meanwhile, quarterly sales grew 17% to $143 million, and net income rose 42% to $47 million, or $0.43 diluted earnings per share.

For the year, earnings of approximately $1.60 per share are expected on revenue of about $530 million, valuing the $44 stock at 27 times estimates. Garmin trades at 23 times forward estimates and 25 times free cash flow, so it isn't inexpensive, but it also isn't too expensive given its growth rate and strong leadership in a growing market.

  Sales    Net Inc.    FCF*1998     $169       $35       $NA1999      232        64        162000      345       105        592001      369       113       1152002      465       142       163YTD^      267        88        80Numbers in millions
*FCF (free cash flow) is cash from operations minus capex.
^YTD is the first six months of 2003.

Primary risks include product innovations (although Garmin leads that charge today) and competitors lowering prices. Cobra Electronics (Nasdaq: COBR  ) is entering the GPS market and doing just that. When a company has 32% profit margins, it will attract competition like bees to honey. Even Microsoft (Nasdaq: MSFT  ) is a potential competitor -- and already is one in software.

This said, industry leaders often climb a wall of worry, using their strong position to remain atop the heap. With consumer sales made through the likes of Best Buy (NYSE: BBY  ) and Wal-Mart (NYSE: WMT  ) , Garmin is reaching out to you. Will you find your way to buying a GPS product? In coming years, I bet many of us will, and that makes Garmin an interesting investment idea.

Jeff Fischerhas had a Garmin GPS since 1999, but didn't find his way to the stock until now. He still doesn't own shares. The Fool has a fulldisclosure policy. If you're looking for more stock ideasHidden GemsandStock Advisor, two best-selling Motley Fool newsletters (in print and online), offer vetted investment ideas every month.


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