Garmin: A bit too expensive, needs to improve profitability

introduction

I wanted to find out Garmin’s (GRMN) Look at how well the company has performed over the past few years and decide if now is a good time to start working for a company known for its performance. The company’s products are durable. Although the company competes in a very saturated wearable market, I believe that its expertise in accessories, which sets it apart from other smartwatches, will continue to attract many customers who want products designed with specific tasks in mind. Therefore, I believe that the company’s products will always be in demand. However, the current stock price makes it a bit expensive to own, which is why I am giving it a Hold rating.

A quick note about finances

the current 24th Q1Submitted on May 1st^st ’24, same company The company has about $2.2 billion in cash and marketable securities against zero debt. This is a great position and should attract many investors who don’t like much leverage. This position allows the company to flexibly allocate resources without worrying about allocating a portion of its cash flow to debt interest payments. This allows the company to focus on rewarding shareholders through organic/inorganic growth, share buybacks, and even dividend increases, although I prefer the first two. It’s fair to say that GRMN is not at risk of bankruptcy and is well positioned to weather any downturn that may come. Now, let’s look at how the company has performed over the years, starting with revenue.

Revenues have been growing steadily for the past decade. Not spectacular growth, but still respectable. And the growth rate has slowed considerably recently, well below the company’s 5- and 10-year CAGRs. This is a bit worrying, but understandable. The company saw a surge in revenues after lockdowns were lifted, as many people returned to outdoor activities, increasing demand. So it’s natural to see growth slowing after years of pent-up demand. The latest quarter saw sequential growth of about 13%, well above the previous year and encouraging.

Over the years, the company’s efficiency and profitability have taken a bit of a hit and have yet to fully recover to pre-COVID levels, but we expect some recovery by the end of 2023. As of Q1 2024, they will have improved further and are very close to FY19 levels.

Speaking of efficiency and profitability, the company’s ROA and ROE have remained consistently high over the past decade, indicating that management is adept at leveraging the company’s assets and shareholder capital to create value. These are well above my minimum required ROA of 5% and ROE of 10%. Additionally, the company’s ROTC, which measures how efficiently management allocates available capital to profitable projects and whether it has any competitive advantage in that area, has declined slightly over the past few years but is recovering and is near the minimum level I consider to be above 10% for a good investment. I believe that companies that can achieve an ROTC above 10% have a competitive advantage and a strong defensive wall.

Overall, GRMN appears to be performing well. The company’s strong financial position will help it weather the upcoming downturn and make strategic decisions to further grow and benefit shareholders in the long term. The company’s profitability and efficiency appear to have improved in recent years, and its competitive advantage appears to have bottomed out and is rising again.

Comments on the outlook

Garmin’s Automotive OEM division seems to be doing very well in the most recent quarter. It grew 58% year over year, but is still operating at a loss. It’s understandable, as scaling takes time. With the operating cash flow the company is currently able to achieve, it wouldn’t hurt to burn some to get the division profitable in the next year or so. The automotive market is expected to remain strong for the next decade as the transition from internal combustion engines to fully electric hybrid vehicles continues, and if the company can continue to win contracts in this division and expand its business, I see this ultimately having a positive impact on the bottom line. Asked about the division’s trajectory from a profitability perspective, the company said it expects further impressive growth, with gross margins in the high teens and operating margins in the mid-single digits. For now, the division represents about 9% of the company’s total revenue, but if it continues to grow at this pace, it is expected to become a major revenue source in the near future. It all depends on finding the right product mix to drive profitability going forward.

There is a lot of competition when it comes to their smartwatches and other wearables, but I don’t think their wearables will become outdated anytime soon. The watches they make serve a specific need in the wearable market. Their fitness trackers and smartwatches are usually high quality, have long lasting batteries, and while they may not look the best, they are designed for an active outdoor lifestyle and are not specifically designed as a fashion accessory like many of the other smartphone watches that big names like Apple have been releasing lately.AAPL). More serious athletes might choose a Garmin smartwatch, which offers more detailed data and more features to help you get the most out of your training and activities.

In niche segments like aviation and marine wearables, Garmin is the established brand and competitors will have a hard time taking away its established market share. Recently, IDC released worldwide shipments of wearable devices, which showed year-over-year growth. Approximately 9%The four most well-known smartphone manufacturers, Apple, Xiaomi (OTCPK:XIACF), Huawei, Samsung (OTCPK:SSNLFHowever, macroeconomic conditions led to consumers loosening their purse strings, causing the average selling price of devices to fall by approximately 11%.

Additionally, with summer just around the corner, we expect growth in each activity segment, including outdoor and fitness, to remain strong. In the most recent quarter, the fitness segment was up 40% year over year, and outdoor was up 11% year over year. We expect outdoor to perform even better in the next quarter, but we’re not sure about the fitness segment, as it was already a phenomenal quarter.

In summary, we may see some decent results in the next quarter. Overall, I think the company’s products are unique enough to attract a certain niche demographic that is interested in pure fitness improvement and outdoor activities and appreciates the durability and reliability of long battery life. In other words, the company’s products will always be in demand. So, let’s see how much I’m willing to pay for the company.

evaluation

I typically like to approach valuation analysis with a conservative outlook, which is why I’ve decided to go with a CAGR of around 6% over the next 10 years for revenue. As I mentioned before, the company’s 10-year CAGR is around 7%, and the latest quarter saw a 20% year-over-year increase. This suggests that the company could grow low double-digit revenue in FY24, which is what I also projected for that year, and is in line with analysts’ expectations. Quoteand the fact that management expects FY2024 revenue to grow about 10% year over year, according to its Q4 2023 records. I generally prefer to gradually reduce growth rates over the next decade, as it’s better to be pessimistic than overly optimistic about a company’s capabilities. This way, I have a higher margin of safety. To get a range of possible outcomes, I also model more conservative and more optimistic outcomes. Below are those estimates.

In terms of margins, they have been very stable over the past decade, so I choose to hold the company’s gross margins stable over the model period, while improving its operating margins by about 100 bps over the next decade. This is consistent with the company’s recent progress. Operating margins have improved 440 bps year-over-year, so I would be comfortable with a 1% improvement in operating margins over the next decade if the Auto OEM division becomes profitable over the next year or so. Here are my estimates:

Therefore, based on the above assumptions, unlevered free cash flow (UFCF) is calculated as follows:

In the DCF analysis, we selected the company’s WACC of 8.4% as the discount rate and a terminal growth rate of 2.5% as we expected this to be at least consistent with the US long-term inflation target.

Additionally, I typically add some discount to the terminal intrinsic value. This is usually determined by the company’s financials, but given the fact that the company has no debt, has an ROTC of over 10%, and is growing, I am comfortable not discounting the company’s fair value. That being said, GRMN’s intrinsic value is around $119 per share, suggesting that it is currently slightly overvalued and it may not be a good time to initiate a position.

Closing remarks

For GRMN to be an attractive investment to me right now, I want to see how the company’s margins trend over the next two to three quarters. I want to see continued gross margin improvement and operating margin improvement. Additionally, I want to see the company’s revenue growth exceed the model above, because at a PE ratio of 25x, the stock is a bit expensive if it grows at the rate I have modeled at this point. I believe that such a PE ratio requires revenue growth to be much higher than 10% in FY24.

The company’s balance sheet is impeccable and it may continue to trade at this multiple as it is likely viewed by many as a safe investment, but I don’t think the risk/reward is balanced if I were to initiate a position at this price right now, so I’m giving it a Hold rating for now, meaning I will refrain from deploying capital.