In a bull market, it seems investors would rather have two birds in the bush than one in the hand. In a bear market, of course, it's just the opposite. Not that investors don't have reason to think they've found something good in Garmin. I believe they have, and wrote as much a few months ago in Garmin's Got It.
A business of results
Garmin, the leading maker of Global Positioning Systems (GPS) products in the world, markets an array of handheld and dash-mounted navigation devices. Founded in 1989, it made its first sale in 1991 and has been profitable since. The company uses a government satellite system free of charge, and first found success supplying GPS tools to the military, then moved into aviation and boating before tackling the general consumer market, selling automobile and handheld GPS devices at the likes of Best Buy
Through the years, and especially its last three as a public company (Garmin IPO'd in late 2000 and weathered the bear market just fine), profit margins, free cash flow, and cash balance have risen sharply. Sales have grown 23% annually since 1996, while net earnings are up 36% annualized. Free cash flow has risen nearly sixfold since 1998, from $28 million to $163 million last year.
Concerns that sales growth will slow markedly with competition and declining prices were put to rest, at least for now, by yesterday's results. Revenues jumped 26% in the quarter -- especially great for summer months -- and are up 22% for the nine months ended September. Consumer products revenue grew 32% on a 37% gain in unit sales, to 517,000 total units. Consumer sales in both North America and Europe were exceptional.
For the year, Garmin now expects sales of about $560 million, up from earlier guidance of around $530 million. Earnings per share for 2003 should be approximately $1.66, up 25% from last year.
What is driving this growth, and will it continue? Addressing the second question first, I believe Garmin's business will continue to perform. The company has distinct advantages over its fledgling (if growing) competitors, including patented technologies and in-house engineering and manufacturing. Both help Garmin speed features to the market first, enabling it to ask higher prices and achieve profit margins in excess of 30%. Operating margins broke a record 40% last quarter.
The price of success
This company has the margins of a powerhouse and the growth rates, even today, of a young success. Yet, it is priced as if margins were only slightly better than average (not four times better), and as if it were growing at rates in the high-teens rather than the mid-20s.
The stock isn't inexpensive -- don't think that. But in a market that trades at 20 times expected earnings, Garmin's 26 multiple on next year's estimates looks reasonable (especially as estimates will likely be raised now that Garmin upped 2003 guidance). If the company continues to grow sales at a 20% clip or greater, and maintain margins and free cash flow growth, the stock should manage a steady climb roughly in line with the increase in earnings, thereby maintaining a market premium.
Would I much rather buy the stock on weakness, now that it has run from $42 to above $50 this week? You bet. The stock is volatile and has offered opportunities in months past, so with luck it will again.
Given Garmin's $150 million trailing free cash flow entering a seasonally strong fourth quarter, the company -- with more than $500 million in cash and investments and no debt -- boasts a $4 billion enterprise value. That puts it at 27 times free cash flow and about 24 times free cash flow by January next year. At recent prices in the mid-$40s, the multiple to free cash flow was in the low 20s -- quite attractive given the growth. So, all else being equal, that's a price to watch for.
Continuing to find growth
Garmin makes a habit of releasing 20 to 25 new products a year, and 2004 will see the same. In the current quarter, five to 10 new products may be rolled out. Recent successes include the first handheld PDA running Palm
Naturally, this story isn't all rah-rah, risks be ignored. Garmin is eyeing the cell phone market, where brutal competition awaits from the likes of Nokia
Meanwhile, the stock is priced for performance. Even buying on weakness demands patience, because in anything but a strong market, the stock's free cash flow multiple could decline to the high teens and still look reasonable rather than undervalued.
But I believe odds are better than not that Garmin continues to tap (and lead) a growing consumer demand for GPS devices. If so, profits should keep rising, and the stock should follow.
Jeff Fischer does not own shares of Garmin, but may at a better price, which is where it was a few days ago (oh well). The Fool has a disclosure policy, as well as buying and selling restrictions for writers. It also asks writers to wear certain hats -- and not just on Halloween.