Switzerland-based Garmin Ltd. (GRMN) has recently wrapped up its 2019; the company beat on both Q4 revenue and adjusted EPS and posted a 12.3% increase in 2019 sales and 21% growth in pro forma EPS. Besides, it increased its quarterly dividend by 7%. Now, especially after the market-wide sell-off fueled by the COVID-19 outbreak and expansion, the stock yields above 2.7%. So, I suppose it is worth examining if GRMN is apt for dividend-oriented investors or not.
The top line
In 2019, strong sales momentum bolstered earnings that reached $952.5 million for the year; revenue improved 12.3%, while pro forma EPS edged 21% higher. GAAP net income improved by 37%. The efficient management of both costs of goods sold (abbreviated as COGS) and operating expenses propped up operating profitability; the operating margin touched 25.2%, while the gross margin climbed to 59.1%.
As a quick refresher, Garmin’s segments are Fitness (e.g., running and multi-sport watches), Outdoor (e.g., handhelds), Marine (e.g., chart plotters and fishfinders), Aviation (e.g., integrated flight desks), and Auto (for instance, OEM solutions). While in 2019 a few of them delivered prodigious revenue growth, Auto and Aviation lagged. That is fully explainable, as the automotive industry was one of the most battered amid the U.S.-China trade confrontation and its repercussions. According to the guidance (see page 11 of the presentation), that is anticipated to remain unchanged this year. Sales of the flagship segments Fitness and Outdoor, as well as Marine, will likely improve by around 10%, while Aviation will remain flat and Auto will contract 5%. In sum, 2020 sales might hit approximately $4 billion.
The cash flow matters
For dividend-focused investors, revenue, profit growth, and margin expansion are sure of some importance, but it is also essential to understand if a company is able to convert its huge revenue into cash flow. So, in 2019, net operating cash flow dived to $698.5 million, while GAAP net income hit $952.5 million for the year. Adjusted net income stood at $849 million. That is a clear sign the company’s working capital was abnormally high. I have taken a look at what precisely drove working capital higher and found out that inventory build-up was the principal culprit. The biggest inventory build-up since 2010 resulted in a $170.2 million outflow. Moreover, the company paid $34.3 million in taxes, while in 2018, its income taxes payable were positive and stood at $35.1 million. Finally, the surge in receivables resulted in a $123.4 million outflow. So, as working capital required huge funds, the company generated less cash available to cover capital investments and return to stockholders.
Speaking about capital intensity, I should say that 2019 Capex/Sales, another ratio a dividend investor should pay attention to, was slightly above 3%. Though it is close to the highest level in the 2010s, it is lower than in 2018 when Garmin invested 4.7% of total revenue in PP&E. After all, I reckon the company’s low-single-digit capital intensity is ultra-low, which is surely good news.
Now let’s turn to free cash flow which is at the crux of dividend sustainability. In 2019, Garmin generated organic FCF (net cash from operations minus additions to PP&E) of $580.5 million and inorganic FCF (with acquisitions factored in) of $281.2 million. Both figures look bleak compared to 2018 when Garmin delivered $763.7 million and $623.4 million, respectively. At the same time, GRMN returned $443.2 million to shareholders in the form of dividends (the bulk of that amount) and buyback.
I have analyzed how GRMN’s organic and inorganic FCF had compared to total shareholder rewards in 2011-2019. The results are presented in the chart below.
The verdict here is that since 2016, GRMN’s organic cash flow surplus has been copious enough to fully cover shareholder rewards; last year, the coverage was 1.3x even despite contracted cash flow. On a side note, the inorganic FCF was weak, as it covered only 63% of the rewards. Anyway, there is a cyclopean amount of cash on the balance sheet ($1.4 billion) that can support dividend payments if FCF falls short of expectations.
Capital efficiency: solid, but there is a room for improvement
As Garmin’s debt stands at null, Return on Equity, as well as its alternatives I frequently use like Cash Return On Equity and FCF ROE are relevant, as the company has been using only shareholder funds to generate returns. Besides, I also would like to touch upon Cash Return On Capital Employed.
As of my analysis, in 2019, GRMN delivered a 15.6% CROE, which looks nice but not ideal. I prefer to see a figure close to 20%. For a broader context, in 2018, GRMN had an around 23% CROE, the stellar result. Also, in 2019 CROCE stood at 14.6%, which is acceptable. Again, as I have mentioned above, the working capital took a toll on 2019 cash flows. So, I hope Garmin will do its best and deliver an above 20% result this year.
Finally, as the chart below shows, GRMN had no obvious CROE or FCF growth or decline trend, as the figures were volatile in the 2010s.
All the figures were calculated by the author using raw data from Seeking Alpha
Brief remarks on valuation
GRMN is trading at ~17.9x Forward P/E (non-GAAP) with a free cash flow yield of approximately 3.3%. Its valuation appears to be slightly inflated, but the EPS growth prospects are likely priced in. Analysts anticipate its revenue to increase by approximately 6% this year, in line with Garmin’s own projections. However, Wall Street has high hopes for EPS. The consensus estimate is 10.4% higher than 2019 adjusted profit per share. Anyway, the stock is richly priced and has no margin of safety, which is essential during the market downturns.
To conclude, as of my analysis, GRMN’s dividend is fully covered by organic free cash flow, but the surplus left after all investing activities is not that strong. Also, from time to time, the company’s working capital substantially reduces cash from operations. On the positive side, Garmin has a gargantuan cash pile, which is solid enough to protect shareholder rewards if FCF dives.
Though I consider the dividend sustainable, it is incalculable how the coronavirus outbreak can impact GRMN’s cash flows in 2020, as the situation is developing rapidly. There is no doubt that coronavirus is the market’s gnawing concern now. During the earnings call, answering an analyst’s question if the company had factored the COVID-19 risks into the 2020 guidance, CEO Mr. Pemble clarified that
So coronavirus, I think it’s still an emerging situation, and the cases seem to be peaking, but we’re watching that. I would say it’s also early in the year, so we don’t — even if there’s some short-term impact, we feel like there’s a lot of room to make up for that. So far, our impact has been minimal, and our safety stock situation has helped us there. If the outbreak continues to go on, then, of course, that would change the game for us and a lot of other people. But for now, we’re optimistic that things are coming back online. Our suppliers seem to be coming back although, obviously, there’s a ramp-up period that we’re managing through all of it.
So, by now, it is not clear enough how sales and cash flow will be affected.
Finally, it seems the market is factoring a much more sizeable risk discount in stocks’ valuations. Investors have been rotating from shares to government bonds that have a reputation for safe-haven investments. The magnitude of the sell-off is scary, and some investors might point out that it is a typical “don’t catch the falling knife” situation. So, I am neutral on GRMN.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.