Garmin's Q3 Was Striking, But So Is The Valuation

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Garmin Ltd.'s Q3 results showed incredibly strong revenue and earnings growth from most segments.The company managed to gain market share in wearables during weak consumer confidence, driven by Garmin...

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(NYSE:GRMN) develops, manufactures and sells wireless devices. The company mostly sells smartwatches through the fitness and outdoor segments, but also has products for aviation, marine, and automotive purposes, including flight decks, boat GPSs, and dash cams among other products. By segment, Fitness generated 26% of sales, Outdoor 32%, Aviation 16%, Marine 18%, and Auto OEM 8% in 2023 with presence in Americas, EMEA, as well as Asia Pacific. With a history of good growth due to constant product innovation, Garmin’s stock has returned incredibly well in the past decade, with a CAGR of 13.6%. On top, the company pays out a dividend with a current yield of 1.5%.   Ten Year Stock Chart (Seeking Alpha) Garmin’s Q3 Report Was Strong Garmin reported the company’s Q3 results on the 30th of October, showing incredibly strong growth momentum. Revenues reached $1.59 billion, growing 24.1% year-on-year and beating Wall Street’s expectations by a wide $144.2 million margin. The growth was rapid across most of Garmin’s segments. Fitness revenues grew 31% driven by strong wearables demand, Outdoor revenues increased 21% with the launch of the fēnix 8 series, and Auto OEM revenues grew at a rapid 53% pace due to growing demand for domain controllers. Notably, the growth in wearables was achieved despite a pressured consumer sentiment in both the US and the Euro Area, those being Garmin’s critical markets. Garmin mentioned during the Q3 earnings call that the company gained around 2.0 percentage points of market share in advanced wearables year-on-year – the performance was also strong in comparison to competitors and when considering the consumer environment. The Aviation segment’s revenues only grew 3%, and the Marine segment’s 22% growth was aided by the prior acquisition of JL Audio – organically, Marine revenues grew 7%.   GRMN Q3/24 Investor Presentation With the increasing revenues, Garmin also beat income expectations by a clear margin – the adjusted EPS of $1.99 beat Wall Street’s expectations by $0.55. In addition to a near record-strong 60.0% gross margin, Garmin’s Q3 operating margin benefited from the strong sales momentum through operating leverage, creating a 6.4 percentage point operating margin expansion into 27.6%. Overall, the quarter was incredibly strong, showing great acceleration from an already good Q2. Given the incredibly strong growth momentum, Garmin again raised its 2024 guidance with the Q3 report. The company now expects 2024 sales to reach $6.12 billion and the EPS to reach $6.85, suggesting Q4 revenue growth of 11.0%. While the Q3 figures were incredibly strong, it appears that the performance is still in part due to quarterly growth fluctuations as the implied Q4 growth outlook stands more moderate, falling closer to Garmin’s long-term growth rate. The Growth Outlook Remains Good, But Not Quite at the Q3 Level Over the long term, Garmin’s growth has also been good, although not quite at the Q3 growth level – from 2014 to Q3/24 LTM revenues, the CAGR stands at 7.8% as Garmin has managed to grow with great smartwatch industry growth. The smartwatch market is still expected by Grand View Research to grow at an 8.2% CAGR from 2022 to 2030 with adoption of fitness tracking and health monitoring, posing a further growth runway in Garmin’s main product. Although competition from Apple’s (AAPL) Apple Watch as well as Samsung (OTCPK:SSNLF), Fitbit, Fossil, and others create significant competitive pressures, Garmin has managed to maintain a good market share with constant research & development spending. For example, in 2023, the company spent $904.7 million or around 17.3% of revenues on R&D to maintain a competitive offering. The strong Q3 performance also highlights Garmin’s maintained ability to maintain and even grow market share, making for excellent organic growth prospects in smartwatches.   Author's Calculation Using TIKR Data On top of product innovation in wearables, the R&D spend has also allowed Garmin to reach new segments with new products. For example, the company’s Auto OEM segment is now growing rapidly, and is looking to reach profitability with a partnership with BMW. The company initially started with a GPS navigation unit for boaters, and the expansion into the smartwatch market also represents Garmin’s opportunistic nature in capturing new markets with the company’s developed technologies. The company is also very active in small acquisitions, recently acquiring Lumishore to advance the company’s Marine offering with underwater LED lighting systems. From 2014 to 2023, the company has spent $888.6 million on cash acquisitions. Altogether, Garmin’s growth prospects stand good, while not at quite the incredibly rapid Q3 pace. The company looks to capture growth from the smartwatch market with its wide range of available products, and ventures into other offerings through R&D and acquisitions to add additional growth prospects on top. GRMN’s Valuation Is Too Expensive While Garmin has managed to grow rapidly, the stock’s valuation has become increasingly tight – the forward P/E currently stands at 28.6, well above the GRMN stock’s average of 20.9 in the past decade.   Ten-Year Average FWD P/E (TIKR) Further, I built a discounted cash flow [DCF] model to estimate a fair value for the GRMN stock. In the DCF model, I estimate continued growth after 2024 – from 2023 to 2033, I estimate a total revenue CAGR of 7.2% with more rapid growth in the near-term years, quite near Garmin’s long-term rate. After 2033, I estimate perpetual growth of 2.5%. With Garmin’s growth, I estimate the company to reach higher margins as Garmin represented good operating leverage in Q3 on top of gross margin expansion. As such, I estimate the EBIT margin to reach 27.0% from a level of 20.9% in 2023. The rapidly growing Auto OEM segment’s lower gross margins look likely to slightly pressure the long-term margin level, countering some operating leverage. Garmin’s cash flow conversion has historically been great, with a moderate need for working capital and capital expenditures.   DCF Model (Author's Calculation) The estimates put Garmin’s fair value at $150.36, 27% below the stock price at the time of writing. A DCF model valuation also suggests quite a notable overvaluation in Garmin’s stock, and the company would need to grow increasingly rapidly to offset the tight valuation. As such, I believe that the stock’s current risk-to-reward is poor despite strong growth tailwinds. CAPM The DCF model uses a weighted average cost of capital of 8.65%. The used WACC is derived from a capital asset pricing model:   CAPM (Author's Calculation) Garmin doesn’t have any interest-bearing debt, and I estimate the company’s financing to stay debt-free for the foreseeable future. To estimate the cost of equity, I use the 10-year bond yield of 4.42% as the risk-free rate. The equity risk premium of 4.11% is Professor Aswath Damodaran’s estimate for the US, updated in July. Yahoo Finance estimates Garmin’s beta at 0.98. With a liquidity premium of 0.2%, the cost of equity and WACC both stand at 8.65%. Takeaway  Garmin’s Q3 results were great. The company grew increasingly rapidly with expanding margins, and raised its 2024 guidance to suggest quite fast growth in Q4 as well. The long-term growth outlook looks more moderate than the Q3 performance, but still at a good level with Garmin’s tailwinds in smartwatches, and the company’s R&D and acquisitions. Although the growth prospects remain good, I believe that Garmin Ltd. stock has a weak risk-to-reward due to its very tight valuation. 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