Thinking About Money

I was fortunate enough to purchase some Garmin stock a bit over a year ago at $47 (now $93) after buying one of their GPS units, and I’ve been wondering whether I should take the money and run. Since the first step to rationalizing my portfolio is to take a look at what I already have sitting around, this seemed a good place to start.

(Before I continue, please take a moment and read my generic philosophy and disclaimer regarding investment advice)

Garmin, for those who don’t know, makes GPS units. It is, near as I can tell, the bulk of their business (not a sideline like Magellan). They make GPS units for aviation and maritime use, but the real interesting part to me is the automotive use, where revenue for the recent quarter has jumped from 42 million to 150 million in the past year.

Having looked at their recent quarterly report, last audited annual report, and some of the news reports, I think there is a strong chance that the professional analysts and media are missing something.

Here are some of the things I found:

Insider TransactionsCompany Insiders have been consistent sellers recently. At first this concerned me, but I ended up deciding that this is probably not significant in this case. The sales were relatively small compared to the size of their overall holdings (one major shareholder dropped about 20% of their stake). More important, sales by the CEO were tiny (looked like option transactions) and he still holds over 21% – most of that in the hands of his wife and children.

R&D

Research and development is critical for any tech company, and while the percentage of revenue spent on R&D has declined, the actual dollar figure is up considerably (due to the dramatic increase in revenue).

Financial Statement

I didn’t see any obvious problems when looking over Garmin’s financial statements. No mysterious footnotes or warnings. Plenty of signs to indicate that their management is expecting further growth including starting up a new assembly line, and commitments to purchase supplies. Very high profit margins which suggest to me that they’ll be able to withstand declining prices and still maintain high profitability. Little debt. Great cash flow. Oh, and the stock is splitting soon, which is generally a good sign.

Market standing and Growth

According to one study Garmin holds 47% of the market share for automotive GPS units in the U.S (See this story). Investing in a dominant player in a growing market is always a good formula for investing, which brings us to the most important part of this analysis.

Consider their change in gross profit from prior year numbers in each sector:

Outdoor/Fitness 32.1%
Marine 42.7%
Aviation -3.7%
Automotive 225%

Or, looking at it another way. A year ago automotive GPS represented 22% of Net sales. This year it represents 47% of sales.

So for me, the key questions in evaluating Garmin are:

1. Can they maintain market share?
2. What is the trend for automotive GPS sales?

As to maintaining market share, I see no reasons why they wouldn’t be able to hold their own. The new assembly line should handle the increased demand. Strong sales and high rankings on Amazon and a diverse product line, along with some actual marketing (including TV ads – more on that later), should help as well.

But what about the trends for automotive GPS sales?

Back in engineering school we were taught to make guestimates – rough estimates based on incomplete information. The following numbers are made up – they are guesses. But they may be good guesses – at least good enough to get a feel for what might be going on.

Let’s guess that Garmin makes an average of $250 revenue on each GPS sold. This is about half of list on a mid-level unit. Because we know Garmin has a small share of the European market, let’s focus on the U.S. and guess that their U.S. sales are $100 million (out of the $150 million for the quarter). That’s 400,000 units or a run rate of 1.6 million units per year. If that represents 47% of the U.S. market, that figure suggests annual GPS sales in the U.S. of about 3.5 million.

It’s only in the past couple of years that I’ve seen people buying auto GPS units (before then you’d really only see them in the built-in units). So it’s probably fair to guess that the total number of automotive GPS units sold in the U.S. to date is under 7 million.

That leaves about 193 million cars in the U.S. alone that could use one of these.

What about new cars? I expect in a few years auto manufacturers will include GPS units in every car, but right now it’s a $2000 to $4000 premium. Many will buy them, but many (like me in fact) will prefer to get a much less expensive after market unit from someone like Garmin – at least in the near term. With about 12 million new cars sold each year in the U.S., that represents an ongoing potential market for the time being of say, 6 million.

Technology adoption is not linear. The rapid increase in automotive sales and the presence (for the first time) of TV commercials for Garmin suggests to me that automotive technology may be tipping – i.e., rising the steep part of the exponential growth curve (See this article). It’s like DVD players, VCRs, and LCD displays. First you have your early adopters, and then it goes mainstream.

I think automotive GPS is going mainstream, crossing the chasm from early adopter to mainstream adoption (See the book “Crossing the Chasm” for more on this).

The analysts who are looking at Garmin’s growth are, near as I can tell, looking at linear growth in the 25% range.

But if auto GPS sales are, in fact, tipping, the equation is very different. If this is the case, Garmin’s sales of automotive GPS’s should increase at the same or greater rate than last year. In other words, by the quarter ending April 2007 their income should look like this at the very least (based on maintaining the current sales increase, which is less than maintaining a current rate of growth, which is itself a conservative number):

Outdoor/Fitness 75 million
Marine 59 million
Aviation 61 million
Automotive 258 million

Total revenue: 453 million, operating income maybe 140 million. At about 109 million shares that’s $1.28/share or $5.14/share for the year. At today’s P/E ration that would suggest a price of $154/share.

True, the P/E ration might be lower which would bring the price down. On the other hand this assumes linear growth. If I’m right about the position on the growth curve, sales will be accelerating.

Let’s try another view. What if GPS sales in the next year reached 10 million units (which would still mean market penetration of under 10%)? If Garmin captures half of that, it’s 1.25 million units a quarter, or 312 million in revenue. Income in this case would be $156 million resulting in $5.75/share for the year.

These numbers may seem like blue sky, but if, in fact, automotive GPS units are moving up the technology adoption curve, these numbers will actually prove to be conservative. If, on the other hand, GPS units are destined to be a high tech niche product, there’s still a good chance Garmin will at least maintain the kinds of revenue and earnings it is exhibiting today. So the level of risk seems relatively small.

Hidden Gold

There’s one more little detail. Did you know that the maps on Garmin GPS units can be updated? Not that everyone will want to update their maps every year, but once they have 20 million or so units out there, at current prices even if they were to convince 20% of the market to update every two years, that would bring in an extra 150 million per year. And with a bit of marketing behind it, maybe a subscription plan, this could definitely turn into a significant revenue stream.

Conclusion

A well run hugely profitable company with a dominant position in a rapidly growing market is anybody’s dream. It’s true that the really big upswing has already taken place in this stock, but for the two to three year timeframe, it looks like a great opportunity to get a nice return with minimal risk.

This entry was posted on Wednesday, June 21st, 2006 at 9:41 am and is filed under Investing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.