Year to date, shares of Garmin (GRMN) are up 47%. But is this stock about to be lost in the woods?
At the end of October, Garmin reported better-than-expected third-quarter results, but after a month the stock sank back down. What happened?
Garmin reported third-quarter earnings of $0.75 per share, which were $0.21 better than the consensus estimate of $0.54. Revenue rose 6.3% to $722.25 million and handily exceeded the $681 million consensus. Gross margin jumped 290 basis points to 56.2%. Management raised fiscal 2016 guidance. The company now sees earnings per share of $2.65 and revenue of $2.95 billion.
Importantly, the company was able to expand its operating margin. Operating margin rose 364.2 basis points to 22.1%, driven by higher gross margins and lower advertising and sales, general and administrative (SG&A) expense.
Free cash flow increased 60.5% to $199 million. The company spent $20 million buying back its shares.
The company reports in five segments: Auto, Aviation, Marine, Outdoors and Fitness. Auto revenue fell 20.5% to $215 million. Aviation revenue of $107 million was up 14% and the marine segment rose 12.3% to $70 million.
Garmin's outdoor business increased 28.3% to $141 million and the fitness category jumped 32.1% to $189 million. Fitness was 26% of revenue and outdoor was 19.5%.
I have two problems with Garmin. First, the auto business continues to slow. Auto revenue fell 20% this quarter and about 17% year to date. Auto is nearly 30% of total revenue, so it's hard to grow earnings when almost one third of your revenue is declining by double digits. Customers are simply using smartphones for auto navigation instead of using a discrete Garmin device.
Second, management's guidance implies Garmin's two fastest-growing segments -- fitness and outdoors -- are slowing into the fourth quarter. Combined, those segments are nearly 60% of operating income. Again, it's not easy to grow earnings if 60% of operating income is slowing.
So, a third of Garmin's revenue is declining by double digits and the other 45% of revenue (fitness and outdoors) is slowing to mid double digits. This leads me to believe earnings will be down next year.
Historically, Garmin trades between 16x and 18x forward estimates. If you assume the company will earn $2.50 a share in fiscal 2017, which would be down almost 6% from the company's guidance of $2.65 a share for 2016, the stock is probably worth around $42.
I would avoid shares of Garmin. I think the valuation is too high and the company's automotive business is slowing too fast. It seems the fitness and outdoors categories are not growing fast enough to offset the auto slowdown. This stock could be lost in the woods.