Should You Buy Garmin’s Dip?

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Should You Buy Garmin’s Dip?

By Chris Worthington, Editor-in-Chief of Income

If you’ve driven a car in the past 15 years, odds are you’ve also used a GPS.

Yet the emergence of smartphones quickly made the stand-alone GPS devices obsolete.

It was a huge wake-up call for Garmin (GRMN) – the company that was once synonymous with automobile GPS navigation.

However, the company has been hard at work diversifying its business, and it remains relevant today.

In fact, Garmin pays an extremely enticing dividend, and the stock looks cheap right now. That’s an unusual combination in today’s market . . .

But is it actually worth an investment?

On April 29, the company reported first-quarter 2015 earnings. Garmin missed on both revenue and earnings per share, and shares plummeted more than 4% on the day, reaching a new 52-week low.

That’s a bad start to the year, but it’s not enough to write off the stock entirely. Thus, to determine if this is actually an opportunity or merely a value trap, we turn to our seven-step system for finding safe, high yield . . .

1) Simple Business

It’s been years since Garmin could rely solely on its automobile GPS systems, and the company has been working hard to diversify its products. Today, Garmin cites five different segments to its business: automotive, marine, outdoor, fitness, and aviation. According to its website, 57% of Garmin’s revenue comes from non-automotive products, a sign of how little the company relies on the products that initially powered its growth.

Unfortunately, Garmin’s business has grown increasingly complicated in an effort to remain relevant – and profitable – following the demise of its GPS niche. With products ranging from bicycle pedal power meters to fish finders to Cessna flight decks, Garmin’s business is no longer quite so simple . . .  and that’s not what we’re looking for.

2) Steady Demand

Generally speaking, Garmin’s revenue has been in precipitous decline since it peaked in 2008. The chart below shows annual revenue over the last seven years:

As you can see, the trend is downward – though revenue did increase in 2014. And while that’s a positive development, much of last year’s revenue growth was powered by the fitness segment, which is facing significantly increased competition.

Specifically, the growth in fitness has been powered in large part by the Forerunner smartwatch . . .  and, as everyone knows, Apple (AAPL) recently invaded the smartwatch arena.

In Garmin’s most recent earnings call, analysts asked about increased competition, particularly from the Apple Watch. CFO Doug Boessen replied that “our products are positioned differently than the Apple Watch, and we appeal to strong active lifestyles.” Forgive me if I’m not totally convinced by that logic.

Meanwhile, demand was mixed in Garmin’s latest quarter. Its fitness division reported 31% year-over-year revenue growth, but other divisions haven’t fared so well.

Revenue from the outdoor segment was below expectations, falling 10% this quarter. Similarly, auto revenue was down 11% this quarter. In the marine segment, revenue grew 7% year over year, but this is attributable to Garmin’s acquisition of Fusion Electronics. The organic business, on the other hand, remained flat year over year. Finally, aviation revenue grew 2% in the quarter, though operating profits were down on a year-over-year basis.

3) Cash Flow Positive

Strictly speaking, Garmin is cash flow positive, having generated $64 million in free cash flow in the most recent quarter. However, both free cash flow and cash from operations have declined significantly since peaking in 2009, as you can see in the chart below:

What’s more, the gap between cash from operations and free cash flow has expanded recently, meaning Garmin’s capital expenditures (capex) are increasing. In fact, Garmin’s capex reached $73.3 million in 2014, a 128% increase since 2010. This is problematic because the business is becoming more capital intensive at the same time that revenue has suffered.

Meanwhile, in the most recent quarter, the company paid significantly more in dividends than it generated in free cash flow ($92 million versus just $64 million), while also repurchasing $16-million worth of shares. This is definitely a trend worth watching, as an extended period of uncovered payouts could put Garmin’s dividend at risk.

4) High Cash Balance

Garmin’s cash and cash equivalents have declined about 7% since peaking in 2011, but the company still maintains a relatively strong balance sheet. Indeed, its dividend is well-covered by its cash reserve. However, as noted above, if cash flow continues to fall short of dividend payouts, even a high cash balance won’t last forever.

5) Minimal Need for Credit

According to Bloomberg, Garmin has had no debt for the last eight years. Combined with a high cash balance, it’s a safe bet that Garmin has little need for credit.

6) Earnings Buffer

According to Morningstar, Garmin has a dividend payout ratio of 100.8% for the last 12 months – and that’s not a good sign. Once again, if Garmin can’t cover its dividend for an extended period, then it’s possible the company could slash its payout.

7) Dividend Grower?

When it comes to dividend-paying stocks, companies that are growing their dividends – not the ones with the highest yield – have proven to be the best investments. Unfortunately, though Garmin’s yield is quite attractive, the company’s dividend growth leaves much to be desired.

Garmin’s one-year dividend growth is a measly 6.3%, which is in line with the bump from 2013 to 2014, as well (6.7%). The year before that, the dividend remained flat. At the end of the day, a three-year dividend growth rate of just 4.3% is not what we’re looking for in a stock.

In Conclusion

Based on our seven-step system, Garmin doesn’t qualify as a worthy dividend investment. Revenue peaked all the way back in 2008, while capex is increasing rapidly. Meanwhile, some of the company’s most profitable products are facing new competition from heavyweights like Apple. Finally, the dividend is growing at an anemic rate.

Bottom line: Steer clear of this once-dominant GPS manufacturer.

Good investing,

Chris Worthington

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By Chris Worthington