"Garmin (Nasdaq: GRMN) Reports Best Quarter and Best Year in Company History," blared the headline on Wednesday.
So why was the stock down 10% at Thursday's close? Seeing as Motley Fool Stock Advisor told you to buy the stock back in October 2005 (it's up 90% since then, by the way, so don't let the recent drop get you down), I figure it's only right that someone here clue you in to the reason for the drop -- and the buying opportunity it provides. So here's the skinny, focusing on the full-year numbers:
Revenue grew 79% to $3.18 billion as Garmin GPS units practically flew off the shelves at all the usual suspects -- Best Buy (NYSE: BBY), Circuit City (NYSE: CC), and Wal-Mart (NYSE: WMT) -- plus a few shops you might not ordinarily think of -- Cabela's (NYSE: CAB), Dick's (NYSE: DKS), and ... as I just learned, Linens 'n' Things! Three business segments (aviation, marine, and outdoor) posted double-digit gains, and automotive/mobile scored a triple-digit hike while making up 74% of Garmin's business. Diluted earnings per share rose 66% to $3.89.
Now the bad news
But why is the stock down? Well, the fact that earnings didn't keep pace with sales growth gives you one clue: You have to blame margin compression for that. CFO Kevin Rauckman tried to put a sunny face on things when he said that 46% gross margins and 29% operating margins were "exceeding our expectations." But investors couldn't fail to notice that those numbers were down around 370 basis points and 270 basis points, respectively.
Guidance didn't do the stock price any favors, either. Garmin told investors to expect 45% revenue growth in automotive GPS sales. That 45% growth might win applause at many companies, but at Garmin, it suggests that growth in this crucial segment will slacken to well less than half of the blistering pace set in 2007.
Overall, we're now looking at 42% revenue growth likely ... but just 13% growth in per-share profits as margins contract on tough price competition from TomTom and Nokia (NYSE: NOK).
Now more good news
On the plus side, Garmin also guided us to expect accelerated revenue growth in the three segments that lagged automotive last year. Management predicts that sales will pick up 30% in aviation, and 25% each in marine and outdoor.
Show me the money
On the cash flow front, Garmin continues to invest its cash profits in expanding a warehouse facility in Kansas and a factory in Taiwan. Also continuing -- those investments' drain on cash, as capital spending raced ahead 69% year over year.
Regardless, the company's superb sales success powered it ahead to generate $525 million in cold, hard, free cash flow. For the record, that's just a smidge under twice the amount of greenbacks Garmin churned out in fiscal 2006. The way I look at it, this leaves the stock priced at a reasonable (well, considering that growth rate, it actually is) 26 times multiple to free cash flow.
Moreover, seeing as from a GAAP perspective, the stock is now priced at less than a 1.0 PEG ratio, I'm thinking Garmin looks mighty attractive long term. Short term, though, shareholders could endure a rough ride as momentum investors, spooked by the margin compression and "slowing" growth rate (remember, we're dropping down all the way to 40% revenue growth), exit the stock.
Meanwhile, across the pond
In related news, Garmin nemesis TomTom also reported earnings yesterday, and took an immediate 8% hit to its stock price in consequence. The reason? Second verse, same as the first -- gross margins are getting squeezed. This was not helped by the fact that TomTom dropped its average selling from -- better sit down for this -- $339 per unit to $208.
Considering that TomTom is targeting 30% market share in the U.S. in 2008, but remains 3 points shy of that target, I'd say that TomTom's prices aren't rising any time soon.
What that means for Garmin investors this year is that one of two things will happen: Either Garmin must cede market share to its Euro-rival, or see its own margins continue falling as these two companies race to the bottom.
