Garmin: Slightly Too Expensive, Needs To Prove It Can Improve Profitability

seekingalpha2024-06-07

Garmin's financial position is strong with $2.2B in cash and no debt, allowing for flexibility in resource allocation.The company has seen steady revenue growth over the past decade, although recent ...

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However, the current share price is expensive.   NguyenDucQuang/iStock Editorial via Getty Images Introduction I wanted to look into Garmin’s (GRMN) performance over the last while to see if it would be a good time to start a position in a company that has been known for its durable wearables. The company is competing in a very saturated wearables market; however, I believe the expertise that makes it stand out from other smartwatches that are more like accessories will continue to attract many customers who are looking for products that are designed with the specific task in mind, therefore, the company’s products will always be in demand in my opinion. However, at the current share price, it is a bit expensive to own; therefore I am assigning a hold rating. Briefly on Financials As of Q1 ’24, which was filed on May 1st ’24, the company had around $2.2B in cash and marketable securities, against no debt. This is a great position to be in, which should attract many investors who are not big fans of leverage. This position allows the company flexibility in how to allocate its resources without worrying about allocating some of the cash flow to paying down interest on debt. This way the company can focus on rewarding shareholders through organic/inorganic growth, share buybacks, or even dividend increases, although, I prefer the first two more. It’s safe to say GRMN is at no risk of insolvency and in a good position to weather any sort of downturn that we may still see later. Now let’s look at how the company performed throughout the years, starting with revenues. In the last decade, we can see a steady increase in the top line. It is not an outstanding growth but respectable, nonetheless. We can also see the most recent growth numbers have slowed down quite a bit and are well below the company’s 5 and 10-year CAGRs, which is a little worrying, however, it makes sense. The company saw rapid growth in sales due to pent-up demand after the lockdowns were lifted, and many people returned to more outdoor activities, therefore, a slowdown in growth after the pent-up years is understandable. In the latest quarter, we can see a sequential increase of around 13% has been achieved, which is well above the previous years and that is promising. Author Over the years, the company’s efficiency and profitability took a slight hit and have not recovered fully to pre-COVID levels just yet, however, we can see a slight recovery at the end of 2023. As of Q1 ’24, these have improved further and are very close to FY19’s levels. Seeking Alpha Continuing with efficiency and profitability, the company’s ROA and ROE have been consistently high over the last decade, which tells me that the management is adept at using the company’s assets and shareholder capital to create value. These are well above my minimums of 5% for ROA and 10% for ROE. Furthermore, the company’s ROTC, which measures how efficiently the management is allocating the available capital to profitable projects, and whether the company has some sort of competitive advantage in the space, has seen a slight decrease over the years but is on a recovery and is at around my minimum that I consider a good investment, which is over 10%. I believe that any company that can achieve ROTC greater than 10% has a competitive advantage and a strong moat. Seeking Alpha Overall, it seems that GRMN is doing pretty well. The company’s strong financial position will help it weather any further downturns, make strategic decisions to further the growth of the company, and reward shareholders in the long run. The company’s profitability and efficiency seem to be improving in recent years, and its competitive advantage seems to have bottomed out and is on the rise once again. Comments on the Outlook Garmin’s automotive OEM segment seems to be progressing very well in the latest quarter. It saw 58% y/y change; however, it is still operating at a loss, which is understandable because it takes time to scale up, and with the operating cash flow the company is able to achieve right now, it is fine to burn some of it to get the segment to profit in the next year or so. Automotive markets are poised to continue to perform well over the next decade, with transitions going from ICEs to bridging the gap to fully EVs via hybrids, and if the company can continue to win contracts in the segment and scale operations, it will eventually contribute positively to the bottom line in my view. When asked about the trajectory of the segment in terms of profitability, the company expects further fantastic growth, with margins to settle at around high-teens on gross, while operating at around mid-single digits. So far, this segment is contributing to around 9% of the company’s total revenues but is expected to become a major revenue generator in the near future if it continues to grow at such a pace. This will all depend on the company’s ability to find the right product mix to prop up profitability going forward. In terms of the company’s smartwatches and other wearables, there is a lot of competition, however, I believe that the company’s wearables will not become obsolete anytime soon. The watches that the company produces cater to a specific need in the wearables market. The fitness trackers and smartwatches usually are of high-quality build, have a long-lasting battery, and may not be the best looking out there but are designed for active lives outdoors and not specifically a fashion accessory like many other smartphone watches these days from known companies like Apple (AAPL). More serious athletes may opt for a Garmin smartwatch which may provide more in-depth data and is filled with many more features to get the best out of a workout or an activity. In terms of more niche areas like aviation and marine wearables, Garmin is the staple name here and the competition will have a hard time taking some of that market share from the company as it is so established already. Recently, IDC published worldwide shipments of wearable devices, which saw a growth of around 9%, which was dominated by the four best-known smartphone makers, Apple, Xiaomi (OTCPK:XIACF), Huawei, and Samsung (OTCPK:SSNLF). However, the average sale price of a device dropped by around 11%, as the macroeconomic conditions weighed on consumers heavily as they tightened their wallets. Furthermore, with the summer just about here now, I am expecting the growth in each of the activity segments like outdoors and fitness to remain strong. In the latest quarters, the fitness segment saw a 40% y/y increase, while outdoors saw around an 11% y/y increase. I believe outdoors will see an even better next quarter, but I’m not sure about the fitness segment as that was a phenomenal quarter already. In summary, in the next quarter, we may see decent results. In the overall outlook, I believe that the company’s products are different enough to attract a certain niche of people who are more into pure fitness progress, and outdoor activities, and who favor the ruggedness and reliability of a long battery life. In short, the company’s products will always be in demand. So, let’s see what I would be willing to pay for the company. Valuation I usually like to approach my valuation analysis with a conservative outlook. So, for revenues, I decided to go with around 6% CAGR over the next decade. As I mentioned previously, the company’s 10-year CAGR was around 7%, and in the latest quarter the company saw a 20% y/y increase, which suggests that the company may see low double-digits for FY24 and that is what I put in for that year too, which coincides with analysts’ estimates, and the fact that management is expecting around 10% y/y increase for FY24, as per Q4 ’23 transcript. I usually like to taper down growth rates over the next decade, as it is better to be more pessimistic about the company’s ability than overly optimistic. This way I am getting a higher margin of safety. To get myself a range of possible outcomes, I am also modeling an even more conservative outcome and a more optimistic one. Below are those estimates. Author In terms of margins, I decided to leave the company’s gross margins stable over the model period since these have been very stable over the last decade, while I decided to improve operating margins by around 100bps over the next decade, which is in line with how the company has progressed in the most recent. Operating margins saw a 440bps improvement y/y, so as the auto OEM segment turns profitable in the next year or so, I don’t see a problem with operating margins seeing a 1% improvement in the next decade. Below are those estimates. Author So, with the above assumptions, we derive our unlevered free cash flow, or UFCF as below.   Author For the DCF analysis, I went with the company’s WACC of 8.4% as my discount rate, and 2.5% terminal growth rate because I would like to see the company at least matching the US long-term inflation goal. Author Furthermore, I usually add some discount to the final intrinsic value, which usually depends on the company’s financial position, and given the fact that the company has no debt, ROTC is above 10% and growing, I am fine without discounting the fair value of the company. With that said, GRMN’s intrinsic value is around $119 a share, suggesting a slight overvaluation currently, and may not be a good time to start a position. Author Closing Comments For GRMN to be an attractive investment to me at this time, I would like to see how the company’s margins progress over the next 2 or 3 quarters. I would like to see improvements in gross margins and to see if operating margins are continuing to improve. Additionally, I would like to see the company’s top-line growth exceed what I have modeled above because right now if it is going to grow at such rates as I modeled, the company is slightly too expensive at a forward PE ratio of 25. Such a PE ratio I believe demands much higher revenue growth than just 10% for FY24.  The company may continue to trade at these multiples because its balance sheet is immaculate, and so could be perceived as a safe investment by many, but if I were to start a position at these prices right now, I think the risk/reward would not be favorable; therefore, I am assigning a hold rating for now, as in I am holding off from putting up any capital.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.30.2","shortVersion":"4.30.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2441725280"}