Garmin Arrives

For Christmas this year, my wife gave me a nuvi.

Get your mind out of the gutter.

A nuvi is a personal navigation device, or PND, from Motley Fool Stock Advisor pick Garmin (Nasdaq: GRMN  ) that combines global positioning system (GPS) navigation, preloaded North American maps, an MP3 player, an Audible (Nasdaq: ADBL  ) book reader, and Bluetooth hands-free dialing for my phone. Such devices were enthusiastic sellers during the recent holiday season. Checking Amazon.com's GPS offerings in November and December routinely showed Garmin holding 18 or more of the top 25 sellers, and even the broader electronics category typically showed eight to 10 Garmin products (mainly PNDs) in the top 100.

Yesterday's results illustrate how enamored of these products consumers really were:

Garmin Q4 Actual

Analyst Q4 Expectations

Garmin 2006 Actual

Analyst Q4 Expectations

Revenue (in millions)

$611.2

$524.0

$1,774

$1,690

EPS (diluted)

$0.82

$0.58

$2.35

$2.07



That's a proper pummeling! And PNDs will be the straw stirring Garmin's drink for the next few years. To meet demand, in 2006 Garmin bought an additional Taiwanese manufacturing facility. To spur demand, the company has spent more aggressively on advertising and brand awareness, culminating in one of the cheesiest (yet most memorable) Super Bowl ads in history.

The rest of the story
Garmin's business is more than just PNDs, although the popularity of such devices is indeed skewing the overall corporate financial results. Most other divisions did pretty well, too; the stories are decent, at least.

Division

Q4 Revenue (in millions)

Full-Year Revenue (in millions)

Q4 Revenue Growth

Full-Year Revenue Growth

Automotive/Mobile (including PNDs)

$445

$1,090

173%

170%

Outdoor/Fitness

$80

$285

16%

20%

Marine

$25

$167

(10%)

5%

Aviation

$61

$233

3%

2%



The outdoor/fitness division was strong, as those products, too, captured public imagination (though not to the same degree as PNDs). My wife, a cyclist, is already bucking for a Garmin Edge for her birthday.

The aviation segment has traditionally been a lumpy grower. In 2002 and 2003, the division turned in growth numbers of 8% and 5%, then followed that up with 42% and 34% in 2004 and 2005. There's every reason to expect that a similar return to growth will occur in 2007, as Garmin is ramping up new all-glass cockpit and retrofit products for private planes. The aviation segment products dominate their respective markets and provide a source of high-margin revenue.

Finally, the marine segment, while posting disappointing results, is in something of a can't-lose position. If, as management believes, the new cartography offerings drive greater product growth (and pay attention to Q2 2007 for the marine segment's biggest quarter), then hopefully they'll keep up with non-PND sales. If they don't succeed in spurring interest, they're already such a relatively small portion of the company's results that they'll grow into greater irrelevance.

Transatlantic battle
There's a war being fought for your PND dollars. On one side, you've got Garmin, dominant in North America with a market share somewhere between 50% and 60%, depending on who's measuring. On the other side of the Atlantic is Dutch company TomTom, dominant in Europe. Garmin is not ceding continental supremacy, though, having purchased a new European headquarters in 2006. European sales rose 88% to $593 million in 2006, and Garmin continues its efforts to build its market share to 20%.

Where might there be dragons?
Two concerns are generally trotted out regarding Garmin. First, there's the idea that its market will migrate away from it. So-called "smart phones" can provide many of the same navigation benefits as PNDs, though the functionality is nowhere near compatible ("yet," naysayers will add). So investors worry that the Palm (Nasdaq: PALM  ) Treo or Apple (Nasdaq: AAPL  ) iPhone will usurp Garmin's PND offerings, and will eventually crater Garmin. Perhaps, but I've never bought into such catastrophic scenarios, simply because I don't believe that those who would be satisfied with smart-phone navigation would have purchased a PND anyway.

Also, Garmin has products across all price points, and the company offers its own Garmin Mobile solution for smart phones, so it's not going quietly. I also remain somewhat unconcerned, because I've owned Garmin long enough to have seen the perennial worrywarts get shown up repeatedly. Three years ago, the fear was that built-in automobile navigation systems would render Garmin's nascent PND offerings irrelevant. That turned out well, didn't it?

The other concern is that Garmin's outsized profitability will be competed away by big players entering the PND space. Notable names bringing PND offerings to market in the past year include Nokia (NYSE: NOK  ) , Sony (NYSE: SNE  ) , and Pioneer. But this, too, is a red herring. Management has consistently and repeatedly stated that PND margins will come down as consumer mass adoption occurs, but that they'll make up profitability on volume.

To doubters, I offer three counterpoints. First: Forewarned is forearmed. Margin migration is no surprise to anyone who's followed Garmin -- management stresses it in every conference call. It's old news, and moreover, it's somewhat slow-moving old news -- operating margins in the just-completed fourth quarter were 32.5%, which is actually up from last year's 30.8%. For 2006, operating margins fell to 31.3% from 32.9% -- again, nowhere near what was expected.

Second, Garmin's vertical integration allows it to drive rapid product development and innovation. That's the real driver of profitability in the PND industry, and there's no company able to keep up. (Do you really think Nokia or Sony will commit the resources to do so when PND sales make up but a tiny portion of their businesses?) I call this competitive advantage -- the Sonys and Nokias of the world are involved, but Garmin is committed. Big difference.

Third, Garmin's Cayman Islands incorporation and Taiwan-based manufacturing result in a low corporate tax rate -- far lower than that of its competition. Getting into a price war with the fattest-margin player in the industry (Garmin) is unwise -- it can out-price-cut you and still earn fat returns.

If there's anything from Garmin's fourth quarter that gives me pause, it's in the area of guidance. For 2007, management expects revenue of $2.5 billion and earnings of $2.70 per share, which represents 41% revenue growth, but only 15% earnings growth. But given Garmin's history of guidance-tromping, I'm actually willing to watch this play out.

Valuation thoughts
I've long maintained a discounted cash flow model on Garmin (link requires a board subscription), and it's been a textbook case of increasing intrinsic value through business execution. Although I prefer to update once the 10-K is filed, I've done a preliminary update with the numbers released this morning. I build in compressing margins, as well as slowing sales, and cut off all growth beyond seven years. My fair value for Garmin today is around $59. I'll be showing the "how-to's" on our Stock Advisor message board, so consider taking a free 30-day trial.

The Foolish bottom line
A successful holiday sales campaign. A hot product. Great management. And a fair stock price. Garmin has been a tremendous long-term investment, one I believe will continue to bear fruit. In the meantime, try out a nuvi, if only to impress your friends.

Amazon, Palm, and Garmin are Motley Fool Stock Advisor selections. To find out all the reasons why, take a free 30-day trial of the market-crushing newsletter service today.

Fool contributor Jim Gillies owns shares of Garmin, and has the following Garmin option positions: long Jan08 $27.50 calls, short Jan08 $52.50 calls, short Jan08 $17.50 puts. Send him feedback if you so desire. The Fool's disclosure policy always knows where its towel is.


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