Thursday, December 21, 2006

Garmin (GRMN)

Garmin (GRMN) is by far the biggest player in the portable navigation device (PND) market - they have around 50% market share. A dominant position does not necessarily make for a good stock, however. Apparently Garmin's GPS devices are expected to be a hot seller for Christmas this year - not that I was aware people want GPS devices for Christmas - but will Garmin stock help add a little green to the tree? I doubt it because the stock is priced with outrageous expectations from analysts and investors. The risks are as follows:

-Selling prices will be under pressure as PNDs become increasingly commoditized, and this will significantly hurt the bottom line. Simply put, Garmin is getting more and more competition, and the effect is that gross margins have been falling constantly over the past few years. Once upon a time they were 57.7%, last quarter they were 48.7%... I consider this to be an irreversible trend the company will need to deal with, yet analyst models assume no further decline in selling prices (and hence gross margins). This is the opposite of what happens with technology, it gets cheaper over time - think about computers.

-Garmin has no recurring revenues. They only make money upon the purchase of their product, not beyond that. If you want a comparable company, think about Dell. Both make money on the purchase, and need their product to break/become useless before the customer buys another one. This is the exact opposite of what you want in a company. Other tech stocks have recurring revenues (think Apple's iTunes, or needing Research in Motion to give your Blackberry service), but Garmin only profits at the point of sale. This will be a significant problem for growing revenues and profits in the future.

-Valuation. GRMN is trading for 40x trailing annual free cash flow, or more than twice the expected growth rate from analysts (which I expect to be higher than will materialize). According to the DCF model, Garmin needs to grow FCF at 20% annually over the next 5 years, and still be able to justify a 30x FCF multiple to be even fairly valued (that means no upside from the current price of $50). I see little to no chance of such a scenario occurring, especially considering Point 1 about declining pricing power leading to lower selling prices.
Garmin is not a bad company. They are very good at what they do. The stock is simply too overhyped thanks to the "it has a cool gadget, the stock must be great" groupthink. I expect to see GRMN head toward $40, unless the entire premium gets wiped out and it goes to the $25-30 fair value range. Either way, I don't think its the kind of good, undervalued stock you want to be in.

One more reason...Garmin's latest holiday commercial now airing on various networks throughout North America.

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