From Standard & Poor's Equity Research
We think the personal navigation device market is poised for mass consumer adoption, and believe Garmin (GRMN
; recent price, $93), as a market leader, is in a prime position to capitalize on the upswing. According to the NPD Group, Garmin maintains about a 50% market share for personal navigation devices sold at retail in the U.S. We see broader consumer adoption of PNDs driven by three factors: lower prices, technology that makes PNDs "must-have" items, and greater consumer awareness.
With what we see as a strong balance sheet that includes no debt and about $7 per share in cash, a track record of solid revenue and earnings-per-share growth, and a reputation for continuous technological innovation, Garmin is a very well-run company, we believe. We also like that Chairman and CEO Min Kao's interests appear to be aligned with shareholders. He owns about 22% of outstanding shares. Given these factors, and what we view as the stock's compelling valuation, we have a 5 STARS (strong buy) ranking on the stock.
Garmin designs, develops, manufactures and markets a diverse family of handheld, portable, and fixed-mount Global Positioning System (GPS)-enabled products and other navigation, communications, and information devices for the general aviation and consumer markets. Garmin's products are sold in approximately 100 countries, through a global network of about 3,000 independent dealers and distributors, as well as through OEMs for certain product lines.
AVIATION OPPORTUNITIES.Products in the consumer segment (78% of 2005 revenues) include personal digital assistant navigation devices, automotive navigation systems with street map and address information, GPS-enabled and stand-alone sonar depth finders for recreational boating and fishing, GPS-enabled training assistants for athletic activities, and GPS-enabled cellular phones.
Outlets for the company's consumer products include mass-market as well as consumer-electronics retail chains, plus retailers in the areas of sporting goods, outdoor speciality products, marine specialty goods, and catalogs.
The aviation segment (22%) consists of panel mount and portable products for use in general aviation aircraft. Garmin's panel-mounted aviation products are sold in the retrofit market, where older aircraft are fitted with the latest electronics from its product line.
Garmin has also expanded its range of aviation electronics offerings to leading general aviation aircraft manufacturers through the installation of the G1000 integrated cockpit system as original equipment in new aircraft. It has also expanded future sales opportunities beyond general aviation OEMs to OEMs in the business jet segment.
ROOM FOR COMPETITION.We think the aviation segment offers good growth prospects for Garmin while diversifying the company's revenue stream. Although we do not expect the segment to grow as quickly as the PND market, we see the segment contributing steady revenue growth that's substantially more profitable than that of the consumer segment.
We anticipate average selling prices for PNDs to decline as device makers look to drive unit sales growth by introducing lower-end products and price points to cost-conscious consumers. Also, we expect that competition will likely drive prices down over time. While more competition is rarely good for a company, we believe that the PND market is thinly penetrated and think there is substantial upside for Garmin even if product prices fall and the company loses some market share in the U.S.
Our view, in part, reflects our expectation that the biggest driver of PND growth will come from products used in automobiles, where Garmin currently derives about 47% of its revenues. Competitor TomTom recently said that only about 7% of U.S. and 13% of European cars have navigation systems, and Telematics Research Group expects shipments of portable and factory-installed auto navigation devices to exceed 16 million units a year by the end of the decade, up from 2.6 million in 2005 (about a 44% compound annual growth rate).
FANCY FEATURES. Another near-term upside from heightened competition, in our view: a substantial amount of increased ad spending, which we think will raise product awareness and disproportionately benefit Garmin in the U.S., given our sense of the company's best-in-class products. We also see opportunity for growth overseas as Garmin shifts some of its focus to Europe.
We think technological innovation is changing the way consumers view PNDs and the products are quickly climbing discretionary spending lists of prospective buyers. Product functionality for in-car devices often includes not only interactive voice navigation instructions, but also real-time traffic updates, embedded MP3 players, cell-phone compatibility, the ability to listen to audio books, and soon, where to get the cheapest gas along your travel route.
As more consumers incorporate auto GPS into their travel routines, we think it will have the added effect of encouraging them to buy products designed to enhance other aspects of their lives.
LOW LEAD TIMES.Offering cutting-edge products is the key to maintaining market leadership in consumer electronics, we believe. All else being equal, consumers are more likely to choose a product with the coolest new technology, in our view. Garmin's first-quarter earnings call provided evidence of this, we believe, with the company noting that approximately 51% of its sales were from products introduced in the previous 12 months.
The process of coming to market quickly with new technology is where we think Garmin has a competitive advantage. The company's engineering and manufacturing processes are vertically integrated, which we believe reduces product introduction lead times and helps to enable cutting-edge products to reach retail shelves more quickly.
Garmin spends about 7% of annual sales on research and development, which is designed to ensure that there are plenty of new products in the pipeline. By contrast, the company's nearest pure-play competitor in the PND space (TomTom) outsources product manufacturing and spends about 2% of sales on R&D. In 2005, Garmin introduced 55 new products, and expects to launch about 50 more in 2006.
DOUBLE-DIGIT GROWTH.After posting 67% sales growth in the first quarter, we see anecdotal evidence of continued strong sales and market share. Upon reviewing bestselling items on Amazon.com (AMZN) on June 14, we found that the top 10, and 26 of the top 50 vehicle GPS units, were Garmin products. For handheld GPS systems, Garmin held the top 12 positions and 33 of the top 50, and for specialty gear Garmin owned the top seven spots and 14 of the top 25. Of the 100 best-selling consumer electronic items selling on Amazon overall, seven were Garmin products.
Overall, we anticipate revenues will grow approximately 41% in 2006, incorporating our outlook for strong growth in each geographic region, double-digit growth in each product segment, and significant new product introductions. After estimated interest income of about $32 million, we forecast that 2006 operating EPS will increase about 32%, to $3.62, from $2.74 in 2005. Our 2005 and 2006 EPS figures exclude non-cash currency translation gains and losses.
In our view, the quality of Garmin's earnings is high, as indicated by our proprietary Standard & Poor's Core Earnings analysis. In the absence of pension-related adjustments, the main impact to earnings quality in 2004 and 2005 came from incorporating stock option expense per share of 5 cents and 6 cents, respectively.
HOW IT COMPARES.For 2006, we have incorporated estimated stock option expense of 7 cents into our operating model, in conjunction with the company's adoption of accounting standard SFAS 123R earlier this year. We note that while certain of the company's foreign subsidiaries do have defined benefit plans, Garmin does not break these costs out as it says neither the obligations nor contributions over the past three years have been significant. U.S.-based Garmin International sponsors defined contribution plans that are expensed to operations.
Our discounted cash-flow valuation suggests an intrinsic value of $116 for Garmin, representing a discount of about 25% based on the current market price and implying a target p-e multiple of about 27 times our 2007 EPS estimate. We note the company has traded in a forward p-e range of 15 to 30 times since 2002.
Using our 2006 EPS estimate and projected EPS growth of 18.4% over the ensuing five-year period, we derive a current p-e to growth ratio (PEG) of about 1.4 times, while our 12-month target price of $116 implies a PEG of 1.7 times. Our target multiple is slightly above a consumer-discretionary multiple of 1.5X and slightly below an S&P Composite 1500 multiple of 1.8X that the respective sectors traded at as recently as late May.
MARGIN VULNERABILITIES?We have a neutral view of the company's corporate-governance practices. Positives to note, in our view, include a board of directors where the majority of members are deemed to be independent, the fact that the CEO has a substantial ownership interest in the company at 21.6%, and that all directors own stock in the company.
Negatives, in our opinion, include a shareholder rights plan that would make it difficult for a third party to acquire Garmin, the ability of the board of directors to issue up to 1,000,000 preferred shares without shareholder approval, and the fact that shareholders may not call a shareholders meeting.
A major risk to our recommendation and target price, in our view, would be faster-than-anticipated operating margin compression. Success in the personal navigation device space is inviting competition, which we expect to drive product prices, and therefore Garmin's operating margin, down. Factoring in operating efficiencies, we anticipate as a result of economies of scale, we have modeled-in operating margin compression of 300 bps for both 2006 and 2007.
Other risks include the failure of suppliers to deliver components in sufficient quantities, increases in raw material costs, and a disruption in the use of the U.S. government's currently free Global Positioning System.
ABILITY TO CHANGE DIRECTION.Longer term, a possible change in consumer preference away from personal navigation devices towards GPS-enabled smart phones and OEM equipment in cars poses a threat if Garmin is unable to capitalize on the change. While we do not see a change in consumer preference as imminent, we view the possibility over the longer term as real.
We believe, however, that Garmin is aware of this possibility. In September, 2005, the company announced that Dollar Thrifty Auto Group would begin offering a customized version of Garmin's StreetPilot c330 portable automotive navigators for rental at 138 locations in the U.S. and Canada. Earlier this year, Enterprise Rent-A-Car also began offering Garmin product navigator to its customers for rental at selected airport locations in the U.S.
Also in September, 2005, the company launched Garmin Mobile, a server-based navigation system available for select handsets on the Sprint PCS network.
TECHNOLOGY IS KEY.Along OEM lines, Garmin began selling products designed for leading OEMs in 2005, including for dealer-installed options specifically designed for many models of Chrysler (DCX), Dodge, Jeep, Jeep Wrangler, and for certain Harley Davidson models. The company also achieved OEM supplier status in September, 2005, for a specific 2006 model of Honda Motorcycle. In addition, Garmin has forged promotional relationships with many other automotive dealers in certain countries, including BMW, Ford (F), Saab, and Mazda (MZDAF).
While these initiatives in and of themselves would not, in our opinion, secure a high growth future if smart phones and OEMs dominate the navigation device market, we think they're a good start. We also believe that as long as the company maintains its focus on cutting-edge technology, it is likely to have a place in the navigation market no matter how it develops.