Garmin, the navigation hardware specialist, reported fantastic Q2 results this week on Wednesday 28th July. With countries emerging from lockdowns and the continued demand for outdoor experiences, Garmin has raised guidance for the full year 2021. This article will examine Garmin’s prospects for investors in line with these results.
Garmin is an American technology company focused on products related to GPS (Global Positioning Services). Garmin, initially named ProNav, was founded in 1983 by Gary Burrell and Min. H. Kao to develop GPS products for the US military. Shortly after its founding, they renamed the business to reflect the first three letters of both of their names. Garmin's success was a true product development story, and by the year 2000, Garmin had sold over 3 million GPS devices and was making 50 different models. Garmin listed on the stock market in 2000 and subsequently acquired various businesses that would be well suited to its GPS offerings.
Garmin's Business Model
Garmin splits itself into five specific business units, which it produces and markets GPS and other applied technologies for. These units are fitness, outdoor, marine, aviation and auto.
Garmin's largest unit today, its fitness segment, incorporates popular products such as fitness trackers and specialist sports trackers. Its fitness segment is a testament to Garmin's ability to flex its GPS prowess within new categories; in 2013, the fitness segment made up only 14% of Garmin's revenues, whereas in 2021, it has grown to roughly 32% of its revenues.
The next largest segment 'outdoors' accounts for roughly 26% of revenues and features products such as overland GPS navigators for serious outdoor enthusiasts, dog trackers starting from £699 and specialist golf watches with 41,000 pre-loaded courses for excellent shot visibility. Whilst this business unit isn't the largest in terms of revenue, it has a much better margin profile than the other units and therefore delivers the largest portion of operating income.
The next two segments, aviation and marine, are roughly the same size, contributing 15% each to total revenues, and they span a vast array of applied technologies for both recreational and commercial purposes in the two segments. The marine segment utilises Garmin's strength in GPS to provide GPS chart plotters for open water navigation but also provides other products unrelated to GPS such as sonar fish finders for angling enthusiasts. The aviation segment houses highly critical systems for recreational, commercial and military aviation such as integrated flight decks, aerospace navigation systems and air traffic and avoidance systems. This segment sells products to OEMs (Original Equipment Manufacturers) or as retro-fits for already built aircraft. Interestingly, the aviation segment has a strong feed through of subscription and service revenue from commercial and military customers, which provides a higher retention rate than new equipment installations.
Lastly, the auto division, which was once the largest source of revenues for Garmin with 50% of sales in 2013. It is now the smallest, only contributing 10% of group sales in 2020. This division has been in decline ever since the creation of the smartphone, with people opting to use GPS mapping services from free mapping tools such as Google, Waze and Apple Maps. Garmin has been 'right-sizing' this business unit to focus on rugged auto activities such as off-road GPS navigation for all-terrain vehicle use, however, this unit still posted a small operating loss in 2020.
Garmin is a hardware business. Whilst Garmin is underpinned by its heritage in navigation technology, it is important to be aware that Garmin still needs to sell its units of hardware to
grow revenues. Unlike many technology businesses that have transitioned to software subscription models, Garmin has remained defined by its hardware products. A reason for this is probably the fact that the underlying technology, GPS, which runs off the Global Positioning Network, is actually a free service across the world and is provided by the US taxpayer. The GPN was built by the Americans in the 1970s, and in the 80s, Ronald Reagan signed an executive order to allow commercial and public use of the service. The fact that GPS is essentially a free service means that the only real way of extracting value from the network is to sell hardware to utilise it.
Q2 2021 Results
Garmin published second quarter 2021 results on Wednesday 28th of July. Partly due to a soft quarter the year prior, Garmin delivered an impressive 53% increase in revenues versus the prior year period to achieve revenue of $1.3 billion for the quarter. Each business unit grew double digits, with the strongest performances in marine +66% and auto +74%.
In terms of profitability, the quarter was also very good, with operating margins above Garmin's average at 28%, driven by strong profit growth in its aviation and outdoors sectors, which are typically the strongest profit drivers for the business.
Demand for outdoor and recreational goods has been strong throughout the first half of 2021, and the removal of travel restrictions has led to a recovery in its auto and aviation sectors. The solid result at Q2 has allowed management to raise guidance for the full year 2021, upping both revenue and EPS guidance to $4.9 billion and $5.50 respectively.
Recent Performance (2018 - 2020)
Looking a little further back, over 2018-2020 Garmin has been achieving a series of solid results. Revenue growth has averaged 10.4% per annum during the period and is mostly underpinned by strong growth in Garmin’s fitness segment, as Garmin has benefitted from the boom in health and wellness catered for by Garmin’s smartwatches and fitness trackers. The company has also remained highly consistent at converting revenues to profits as its operating margin has sat consistently between 23% - 25% during the period.
Despite relatively solid results, Garmin’s business had been held back over the recent years as the business recovered from its troubles related to the loss of business in its auto navigation segment. Garmin used to be a market leader in automotive GPS navigation products until companies such as Google and Apple started making smartphone navigational services for free. Once the crown jewel in Garmin’s portfolio, comprising 58% of revenues in 2011, the auto segment now contributes just 11% of revenues and is a drag on operating profits, as the segment currently produces a negligible loss.
With the automotive business now a relatively small contributor to group revenues, its drag on growth and profits should remain minimal. The larger, faster growing segments such as fitness and outdoors have grown into much larger weightings in the Garmin product portfolio, thus revenue growth should continue its trajectory going forwards.
Garmin’s end markets are weighted to outdoor living. After an almost two year period of excessive indoor lockdowns it is likely people will resume travelling and outdoor activities with high frequency post Covid-19. The link between a boost in domestic outdoor activities and Covid-19 prevalence has been well documented and companies with products tailored to this market have done very well. As seen in the chart above, Kampgrounds of America, an industry body for North American camping businesses, expected 2.4 million new introductions to camping in 2020, versus the actual delivery of over 10 million new people to the experience.
Another source of confidence in the likelihood of retention of demand in the outdoor sector is the
installed base effect. 2020 saw some serious growth in purchasing activity for big-ticket items such as boats, RVs and all-terrain vehicles. As seen in the KOA report above, RV usage statistics show that ownership amongst RV users has steeply increased to 74% from 62% in 2020. This reflects the great results that both boat builders like Brunswick Corp and RV manufacturers such as Winnebago and Thor Industries have had during the year of 2020. These are fairly big-ticket items, with most RVs retailing in the range of $100,000 - $200,000; equally with pleasure boats and all-terrain vehicles, purchase prices tend to be $50,000+. The large investment required for these products likely ensures a high frequency of use from customers looking to maximise the value of purchases.
Much of these big ticket purchases such as boats, RV’s and campervans will lead to purchasing Garmin’s products for navigation and other services related to the overall use of these big ticket items.
Even before Covid-19 struck, Garmin was benefitting from a secular tailwind in its fitness segment. Health and wellness is a rapidly growing industry as the developed world starts to prioritise health from a personal, corporate and governmental perspective. Despite the obvious personal benefits from health and wellness, corporate companies are increasingly providing health benefits such as reimbursements for fitness spending, the provision of fitness trackers to employees and charity step competitions as they recognise the value of a healthy workforce. Governments are also prioritising earlier intervention in healthcare and putting money behind the prevention of obesity related diseases such as Type 2 diabetes. All this focus on health and wellness has led to a red hot fitness market over the last 5 years and will continue to underpin growth for the respective segments related to health and wellness for Garmin.
Forever The Innovator
Innovation is part of Garmin’s genetic make up as a vertically integrated business that owns its whole supply chain from concept and design to manufacture and sales through its online and flagship store premises.
After the steep decline in demand for Garmin’s automotive products, Garmin's resurgence as a company providing top quality fitness and sports trackers is one of the greatest turnaround stories in recent history. Garmin’s broad product lines in its five respective segments allows for flexibility and innovation related to the trends seen in each niche area.
As a snapshot of the Q2 earnings presentation, in each of its five sectors, Garmin launched these new products:
Auto: Garmin launched the dezl OTR500, a truck navigator that adds PrePass weigh station bypass notifications saving drivers time, fuel and money. They also launched their first connected dash cam with automatic video storage and live view monitoring options.
Marine: Garmin launched the MSC 10 marine satellite compass, a GPS-based navigation tool with multi-band GNSS and a fully integrated attitude and heading reference system for a smooth and accurate GPS-derived heading and position on the water.
Outdoor: Garmin launched Descent Mk2S, a stylish smartwatch featuring multiple dive modes, multisport training and smart features.
Fitness: Garmin launched the Forerunner 945 LTE, bringing safety and real-time tracking features to their premium GPS running smartwatch.
During the quarter, Garmin also won the prestigious Robert J. Collier Trophy for the world’s first autonomous system designed to activate during an emergency to safely fly and land an aircraft without human interaction.
A likely driver for excellence in innovation would be the large founder ownership still held in the business by Min Kao and Jonathan Burrell (Son of Gary Burrell, Co-founder).
These product innovations not only drive top line revenue growth for the core business but also cement Garmin’s lead as a quality producer of added value products in its respective niches. With a research and development spend of 17% of sales in 2020 equivalent to $700 million, I would expect this innovation to continue from Garmin.
Competition: The biggest risk to Garmin is one that has presented itself in the past. Garmin’s core service utilises a free to use service – the GPS network. Thus, Garmin is somewhat exposed to technology groups that can utilise GPS to produce their own software applications. This led to the complete devastation of its auto business segment post the launch of Google maps in 2005.
With a raft of competitors in fitness trackers such as Apple and Fitbit, Garmin will have to stay nimble in this segment, and the other navigational applications in the outdoors segment could face competitive pressure from the likes of Apple.
Garmin has done a lot of work over the recent years to insulate itself from competitive shocks that the likes of Google imposed on them in the past. Its hardware is increasingly niche, such as the FishFinder ecolocator or the recently launched specialist navigation systems for freight trucks. More revenue also comes from OEM installed equipment such as the integrated flight decks in the aviation segment.
Hardware cyclicality: A second challenge I see for Garmin is the cyclical nature of leisure hardware spending. We sometimes like to kid ourselves into ‘needing’ a nice new fitness watch or a golf smart tracker, however, in reality, most of Garmin’s products are modern day luxury items. Very few people or businesses using Garmin’s products require them to operate, and thus, during a period of tough economic circumstances, I'd expect Garmin to suffer. Whilst Garmin is experimenting with more subscription style services for some of its more high end applications and its aviation segment provides a critical service to commercial aircraft, I think Garmin is still exposed to the economic cycle.
Looking at the financial table above for Garmin, we can see the business has a track record for delivering solid results in terms of both growth and profitability. Looking at revenue, growth has been positive over the last five years, growing sequentially as the drag from the auto segment is offset by the growing scale of other successful divisions. Throughout the period, Garmin has held gross margins at around 57-59%, showing it has strong pricing power for its hardware. The company also has an impressive operating margin of 24% on average, very similar to that of Apple during the period, which is testament to its strong cost control. Looking at return on capital employed (a key calculation for a quality investment), Garmin has produced an average ROCE of 17.8% over the period above — again, a very decent result for a business selling hardware.
Lastly, looking at the balance sheet, Garmin has typically been very prudent, with a very low debt to equity ratio of <0.3, showing the business is not highly leveraged. Garmin also has roughly $3.2 billion of cash and marketable securities as of Q2 2021.
Summary and Valuation
Overall, Garmin is a high quality business, with a well structured product portfolio that should benefit from a general increase in outdoor related spending as we come out of the pandemic. Results so far in the first half of the year only underpin this thesis with a raise in guidance, improvement in margins and a strong forecast rise in earnings per share.
Garmin’s flexible model, proven history of adapting to change and high levels of founder ownership mean the company is in a great position to compound investor returns over the long term. With a price to earnings ratio of 28 in 2021, falling to a PE of 25 of estimated earnings in 2022, Garmin isn’t ‘a bargain’. However, I think the price represents a fair valuation for a business with such quality and scope for growth in the coming years.