Garmin (GRMN)

According to a CIBC report, the bank believes that the market for portable navigation devices (PNDs) faces considerable growth opportunities, in our view. There are over 430M vehicles on the road in N. America and E. Europe; fewer than 10% now have GPS.

It is not difficult to see why Garmin was a popular growth stock. The GPS market has taken off over the last 5 years, as prices for automotive and handheld devices have fallen, attracting the interest of consumers. Garmin has grown revenues at a 53% annual clip since 2004, and earnings at an eye-popping 50% per year. This growth is expected to continue over the next few years. Even in 2007, only 10% of vehicles sold in the U.S. and Europe had navigation devices, leaving a large addressable market. As auto manufacturers continue to compete on features, GPS devices figure to see unit growth. Handheld units are expected to show similar growth, with gross sales projected to triple by 2012. Clearly, organic market growth is on Garmin's side.

things Garmin has going for it are management and financial strength. The company is run by co-founder, CEO, and Chairman Min Kao. Kao is deeply vested in his company, owning 20% of the shares. That's 1.8 billion dollars in personal wealth, so we can be sure he cares about the stock price! Insider ownership is part of the culture, as executives and board members own nearly 50% of the company. Governance is good also. Despite Garmin's excellent performance over the past 5 years, compensation is very reasonable. Management focuses on free cash flow and return on capital, which are the two things that all businesses should be focused on (not earnings per share, which are easily manipulated).

This great leadership is reflected in Garmin's financial health. The firm has 616 million in cash with no debt, has delivered over 50% average return on capital and 23% free cash flow margins since 2003. How many technology based growth companies can you name that pay a dividend? Garmin does, and at current prices it's a market average 1.8% yield. Not too bad for a company expected to deliver 17% annual gains over the next 5 years.

The company is highly profitable and has $1 billion, or nearly $5 a share, of cash and and marketable securities on its balance sheet and no debt. When you back out the cash it’s trading for about 8 times this year’s forecast earnings. That’s cheap for a company with the leading product in a hot market that is growing much faster than that.

It's pretty clear we have a great company, and statistically speaking it's quite cheap too.

GPS maker Garmin (GRMN) is getting torched again today after reporting disappointing 2nd quarter earnings before the open (GRMN 2nd Quarter Earnings Release). They reported earnings of 94 cents a share, excluding a 25 cent per share gain on the sale of some stock they owned in another company, which is below analyst estimates for $1.00. They also lowered their full year outlook to EPS of $4.13 a share on revenue of $3.9 billion from EPS in excess of $4.40 on revenue in excess of $4.5 billion (GRMN 4th Quarter Earnings Release, pg. 3).

Garmin makes those cool, or annoying, Global Positioning Systems (GPS) found in cars that tell people how to get where they’re going: “Make a left at Rosecrans. Make a left at Rosecrans. Thank You...... Re-calculating route..... Re-calculating route.” It’s a pretty cool product, at least in concept, that is useful to a lot of people who don’t want to be bothered with maps.

But the stock, one of the hottest performers of 2007, has been completely torched this year (GRMN 2 Year Chart). Sales growth, profit growth and margins are all declining.

Garmin (NasdaqGS: GRMN), whose shares closed at a 52-week low of $35.19, is now on the verge of being one of the top value plays on the market today. Investors hammered Garmin in response to lowered guidance and a delay of it’s new smartphone, dubbed “nuvifone.” Was this response an over-reaction?

Yes it was. Keep in mind that the price of a stock always (and I do mean always) both rises and falls faster than the intrinsic value of the company. I don’t really care much for the rises (because I’m not a trader), but the falls - if unnecessarily harsh - present an extraordinary opportunity for long-term value investors to get in with new money, either initiating a position or averaging down. I employ the same strategy for my Marketocracy.com portfolio (outperforming by 35% annually, ticker FVF), my Small Cap Momentum model portfolio (outperforming by roughly 60% annually), and my Investment Advisor Newsletter (outperforming by 5% annually); and each has outperformed the S&P 500 by quite a bit.

So why Garmin, and why now?

To begin with, Garmin is quite undervalued if you step back and take a look at the whole world’s appetite for GPS equipment. With a forward price-to-earnings, using their 2008 guidance, of just above 8, investors seem to think that Garmin will no longer grow their earnings. I understand their arguments that margins are being pressured by competitors, and that the stalling of the American economy will hurt sales. I both understand and agree with those statements.

But saying Garmin won’t grow earnings in the next 2 years (which is the timeframe I like to look at stocks for) is just insane. Is the market that short-sighted? Apparently, the answer is yes. Sure, they’re taking a gamble on their new smart phones, but what about their tried and true business of selling the very best GPS systems for a growing market of GPS users? Nearly all car manufacturers are now building their cars with room for an in-dash GPS. Out of everyone I know, less than half have a GPS in their car.

Yes, but what about competition?

Competition is certainly part of the equation. There is no doubt that competition is heating up, including pure-play GPS competition like TomTom and non pure-play GPS competition like Apple’s (Nasdaq: AAPL) iPhone. I’m not entirely sure about TomTom’s numbers, but I do know that everyone I know who owns a GPS, owns a Garmin. Not surprisingly, Garmin has overtaken TomTom in global sales, after two years of solid market domination by TomTom.

As for Apple, and other non-pure play GPS manufacturers, they are newcomers. Garmin has been doing this for almost 20 years and knows their market extremely well. Apple’s iPhone GPS is great if you’re walking around, but in a car it’s clumsy and doesn’t offer nearly as many extras as stand-alone GPS systems do. Besides, Garmin is synonymous with GPS. When I ask people if they have a GPS, I don’t say GPS, I say Garmin. It’s subconscious, and it’s possible that I’m just strange, but I’ve heard others do the same. That’s pretty solid brand recognition. And I tell everyone to buy a Garmin, not because I have any incentive to (I don’t own any stock in them), but because they create a fantastic suite of products.

Additionally, I seriously doubt that Apple - or any other non-pure GPS company, will develop an in-dashboard unit for sale with new cars. It might happen eventually, sure, but I think it would be a flop for the first few years, simply because Garmin and TomTom are so deeply entrenched.

Last, but certainly not least, is the fact that Garmin has great operating cash flow, heavy insider ownership (40%), $600 million in cash (a share buyback or dividend is coming, perhaps?) and solid margins. There’s also heavy short-interest in this company which could lead to an impressive short squeeze, as shorts take their newfound gains of today.

The reason cited for Garmin's recent bid to buy map-data supplier TeleAtlas is that Garmin does not want to be dependent on Nokia considering that Nokia is on track to complete their purchase of Garmin's main map-data supplier, Navteq. TeleAtlas is the only other supplier in the world, so Garmin needs to buy them in order to ensure access to the data that drives their GPS business. Or does it?

TomTom is the closest pure-play GPS competitor to Garmin. They had offered to buy their primary map supplier, TeleAtlas, even before Nokia's announcement to buy Navteq.

Garmin, which has a better cash position than TomTom has, in my opinion, taken this opportunity to squeeze TomTom in a classic poker move. Garmin does not need or want to own TeleAtlas. TeleAtlas' data is inferior to Navteq's and will take considerable resources to reconfigure Garmin's devices to use their data. Navteq has a supply agreement with Garmin for atleast long enough to allow Garmin to develop their own mapping database for far less than even their current bid for TeleAtlas.

Garmin has basically raised TomTom on the poker table and TeleAtlas has unwittingly helped by giving their partner, TomTom, only 5-days to match the offer. TomTom could barely afford their earlier offer of $2.5B. Garmin, in a brilliant move, is forcing TomTom to pay even more.

TomTom will get TeleAtlas, but they will have to spend more for it, further eroding their competitiveness against Garmin.

Garmin, depending on how gutsy they are might raise their offer again if TomTom matches the $3.3B. This will drive Garmin's stock down even further in the short term, but the eventual rise in its stock once this game is played through, will leave Garmin, and its stock, in a much better position.

Stock is oversold at this point (2/28/08 $62)for a company still with growth potential and popular product lines. As a manufacturer of superior innovative products, competition will not be as large a factor as many predict.