Introducing Smartphones Unlikely To Save GPS Hardware Firms Like Garmin

Many investors often confuse good products for good stocks. Surely the two can go hand in hand, but that is not always the case. Although they make great products, I am wary of standalone GPS hardware companies such as Garmin (GRMN). With smartphones quickly becoming multipurpose devices, including GPS, the market for standalone GPS devices is likely going to suffer from lower unit volumes and even more importantly, pricing pressure in the not-too-distant future.

There is no doubt that I envision a time five or ten years from now when all new cars come equipped with GPS in their dashboards, but the odds of price erosion not playing a role in such volume increases are slim. Companies seem to understand this likely future trend. In fact, Garmin is getting ready to launch its own smartphone to get into the GPS-enabled cell phone market. I feel comfortable predicting a Garmin phone will not be very successful.

The longer term trend will likely result in unimpressive volume growth for standalone GPS devices and large price cuts. It is very difficult to maintain profit margins at reasonably high levels when a service like GPS becomes commoditized and available through additional channels. With such market dynamics, it is reasonable to expect revenue could rise while profits actually fall, which would severely hurt the stock prices of GPS device makers like Garmin.

The stock today, fetching more than $31 per share, isn’t all that expensive on an earnings basis (~12.5 times 2009 estimates), but it is the profit estimates that I would be worried about. In fact, the consensus thinks GRMN’s earnings will drop 12% next year, on flat sales, so people do realize Garmin faces headwinds going forward.

The price-to-sales multiple on GRMN would worry me further if I owned the stock. Hardware firms typically have low profit margins and thus low revenue multiples (Apple is a rare exception because their brand and unique product lineup fetch higher prices), but Garmin trades with an equity market value of $6.34 billion, which is more than 2.3 times revenue of $2.7 billion. That is a high sales multiple for a hardware company.

Garmin’s strong balance sheet ($1.5 billion in cash, no debt) likely contributes to the loftier-than-average valuation, but no amount of cash will be able to change the market dynamics for GPS device companies in coming years. If I owned GRMN stock I would closely monitor the situation at the very least. If I was looking to pair some shorts up with longs in the technology space, GRMN would be one to consider in terms of firms facing technological and pricing headwinds over the intermediate to longer term.

Full Disclosure: No position in GRMN at the time of writing, but positions may change at any time

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6 Thoughts on “Introducing Smartphones Unlikely To Save GPS Hardware Firms Like Garmin

  1. I like your thought process and rationale re GRMN. Who do you prefer in smartphone-related companies. What is your opinion re investment-worthiness of CHL? QCOM? SY? for example?

  2. Chad Brand on September 4, 2009 at 8:25 AM said:

    At this point I am really not a buyer of much in this market environment. Of the three you mentioned, I would rank them CHL, SY, and QCOM (based on quality of the company and valuation together), but I don’t have any smartphone screaming buys on my radar at this point in time. If we get a market correction, that could easily change though.

  3. Good read. You haven’t been very active on kaChing lately. Do you plan to sit out patiently until the market corrects?

  4. Chad Brand on September 4, 2009 at 9:22 AM said:

    Well, I’m more of a longer term investor anyway, so active trading isn’t my game. But yes, I am not an aggressive buyer of stocks at current levels. My fair value S&P 500 target has been ~1,050 so right now the risk-reward situation isn’t all that compelling generally speaking in the market. I always have stocks I like, but I am keeping above-average cash right now, waiting for a correction to pounce.

  5. I fully agree on GRMN.

    They are in the same position today in which companies like Franklin Electronic Publishers (FEP) was 10 years ago and PALM were just a few years ago.

    Well almost. GPS has some enterprise market as well.

    Still, Garmin is in for bad times and will likely be switching in acquisition mode soon.

  6. Surely all these telcos competing for similar markets will drive some consolidation and strategic mergers soon. Mobile phones now all contain cameras, in a couple of years time what will be the need for a seperate sat nav device?

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