Grand news for Garmin shareholders (NASDAQ:GRMN); judging from Mr. Market's reaction to yesterday's earnings news, not everyone hates your stock.
At least, not anymore, and the approval is conditional upon continued good behavior.
Garmin not only showed some real progress in its business, but promised to tackle its most important issue head-on ("apply directly to the inventories"). First, let's review what Garmin accomplished last quarter:
Sell 'dem gizmos ...
First and foremost, the company exceeded expectations. Q3 revenues climbed 19% to $870 million, headlined by strong 35% growth in the firm's second-largest GPS segment, outdoor/fitness. Meanwhile, the flagship automotive/mobile unit turned in a robust 21%.
Whatever the cost ...
As expected, however, margin pressures continued to squeeze profits on those sales. Gross margin slid 260 basis points, and operating margins fell even harder, dropping 480 b.p. to 24.6% compared to the third quarter last year. While that won't elicit any tears from smartphone makers like Motorola (NYSE:MOT), Research In Motion (NASDAQ:RIMM), Nokia (NYSE:NOK), or Apple (NASDAQ:AAPL), whose turf Garmin still aims to invade, it's still a sight shy of what we're used to Garmin producing
... Because the benefits are worth it
But here's the good news about falling margins -- by taking the hit, Garmin's made real progress in working down its inventories. Up 125% year over year at the end of Q2, they're now down to a still-too-high, but less frightening 42% increase for Q3. What's more, management promised to "reduce inventory levels by approximately $150 million by the end of the year."
That'll be a neat trick, and foreshadows further margin erosion. But if Garmin can make good on its goal, we could see inventories fall to around $550 million by year's end. That would work out to a year-over-year increase of less than 10% -- far below the pace of sales growth. In other words, Garmin could put an end to its inventory glut (and my incessant harping on same) in the space of as little as three months.
And this story could get better still. Slowing its inventory pileup helped Garmin generate $202 million in free cash flow in Q3, bringing the company's rolling tally up to around $500 million. That gives Garmin a price-to-free-cash-flow ratio of approximately 9, versus predicted growth of 14% per year. If free cash flow continues to swell through further inventory liquidation in Q4, that valuation could get more attractive still.
Need I even say it? Garmin is cheap.
