GRMN - Garmin: Growth Remains Intact But Valuation Is Not Attractive

2023-11-16 10:22:10 ET

Summary

• Garmin is well-positioned for sales growth in the medium term due to strong product offerings in fitness, marine, and auto OEM sectors.
• Q3 performance was strong, driven by new product launches and the festive shopping season, leading to an upgrade in sales guidance for 2023.
• Garmin's innovative products are fueling growth in its marine sales, while also maintaining a prominent position in the high-priced smartwatch segment.

Thesis

Garmin Ltd. ( GRMN ) is well-positioned to maintain its sales growth in the medium term due to strong product offerings in the fitness, marine, and auto OEM sectors. Garmin's strategy of specializing in unique smartwatches equipped with precise GPS, emergency SOS capabilities, and solar charging positions the company to maintain higher-than-average selling prices compared to its competitors. This focus on premium features is expected to benefit its long-term profit margins despite potential short-term challenges related to shipping costs and currency fluctuations. However, the stock is currently trading at a high valuation, and I do not see an attractive risk/reward from here, which is why I assign a hold rating to the stock.

Q3 Review and Outlook

Garmin's prospects for the fourth quarter look promising, driven by the launch of new products and the festive shopping season. The company's strong performance in wearables and auto OEM in the third quarter has led to an upgrade in its sales guidance for 2023, with a 2% increase. In the third quarter, the fitness and outdoor segments accounted for 60% and 24% of the incremental sales, a trend that is expected to continue following the introduction of Venu 3 and vivoactive 5 smartwatches, as well as the tactix 7 adventure watches, just in time for holiday gifting. However, I expect the full-year operating margin to decrease, compared to 21.2% in 2022, with the inclusion of JL Audio, a recently-acquired unit with a lower margin profile, into the marine segment, which accounted for 18% of sales over the nine-month period.

Innovative Products Fueling Garmin's Marine Sales Growth

Garmin is a prominent global manufacturer of recreational marine electronics, facing competition from companies like Furuno, Johnson Outdoors, Brunswick, and Raymarine, which is owned by Teledyne. The introduction of new products is playing a crucial role in broadening their target markets and sustaining growth in marine sales. For instance, the LiveScope XR sonar line has the potential to extend the application of underwater live-scanning technology, catering to coastal and deep-lake fishing enthusiasts. Additionally, Garmin's ECHOMAP UHD2 chartplotter series offers improved display resolution, viewing angles, and accuracy. Furthermore, Garmin benefits from a longstanding OEM (Original Equipment Manufacturer) agreement to supply Brunswick's Bayliner Boats, known for producing motorboats and cruisers equipped with GPS mapping and very high-frequency-radios, providing an added boost to their marine business.

Second Only to Apple in High-Priced Smartwatches

While Garmin may not reach the same market scale as competitors like Apple (AAPL), Huawei, or Samsung (SSNLF), I expect it to maintain a prominent position in the premium smartwatch segment. These competitors collectively account for around half of the smartwatch unit shipments , compared to Garmin's 4% market share , and might continue to dominate with new products and a sticky ecosystem that comprises smartphones and other electronics. Nevertheless, Garmin has managed to secure a significant share in the high-end segment (above $500), ranking second only to Apple. Garmin is likely to maintain this position by offering in-depth features that appeal to outdoor and fitness enthusiasts. As a result, I believe Garmin can successfully defend its market share against Apple's latest Watch Ultra, which appears to cater more to casual adventurers.

Moreover, the company has a growing market opportunity in India, where changing lifestyles, increasing disposable incomes, and improved living standards are expected to continue driving the popularity of wireless sports and fitness equipment. This trend has contributed to India becoming the world's second-largest smartwatch market, surpassing the United States in 2022. The trend is likely to persist as more Indians prioritize health and fitness and opt for smartwatches that offer features like sleep tracking, heart rate monitoring, and physical activity tracking.

Financial Outlook and Valuation

Garmin's strategic focus on specialized smartwatches with features like accurate GPS, emergency SOS, and solar charging positions it to maintain a higher-than-average selling price compared to its competitors. This approach is promising for its long-term profitability despite potential short-term challenges related to shipping costs and currency fluctuations. As people resume outdoor activities, outdoor product sales are expected to rise, partially offsetting the normalization of indoor fitness product demand after the pandemic-driven surge in indoor cycling products. Garmin's strong product lineup, growing popularity in India, and relatively high average selling price are likely to continue driving this trend, particularly in the fitness segment. However, the stock is trading at a premium at 22x forward P/E, and while a substantial share buyback program (similar to Apple's) and flexibility in its balance sheet for acquisitions could support a bullish case, these actions are unlikely in the near term, which is why I am staying cautious until I see the macro-outlook improving and the stock trading at a more reasonable valuation. Hence, I assign a hold rating to the stock currently.

Conclusion

Garmin operates in the growing fitness industry and is recognized for producing top-tier products with robust profit margins. The company places a strong emphasis on research and development, particularly in specialized markets. Over the last ten years, Garmin has gone through significant changes to address the challenges brought about by smartphones disrupting the GPS/PND market. However, Garmin is not impervious to the impact of macro headwinds, potential inventory challenges, and shifts in consumer spending habits, all of which could exert pressure on its profitability. Furthermore, the introduction of the new Apple Watch Ultra presents a competitive threat that could potentially affect Garmin's revenue and earnings, especially in its more profitable Outdoor segment. The stock is currently trading at a high valuation, which is why I assign a hold rating to the stock.

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