Garmin Ltd. (GRMN - Annual Report) announced a record quarter ended June 30, 2007. Total revenue was $742 million, up 72% from $433 million in second quarter 2006 and blasted past the $646 million consensus estimate. Diluted earnings per share increased 75% to $0.98 from $0.56 in second quarter 2006 and far, far ahead of the $0.73 consensus. Excluding foreign exchange, EPS increased 82% to $1.00 from $0.55 in the same quarter in 2006. It is rare to see a company hurt by exchange rates these days, but given the magnitude of the revenue and earnings surprises the exchange rate issues fall into the who-cares category.

Guidance for the full year was increased to at least $2.8 billion in revenue and $3.15 in earnings per share.  The prior consensus estimates were for $2.62 billion in sales and $2.90 in earnings per share.

Valuation-wise, Garmin is trading at approximately 30x its earnings and free cash flow. While this is a rich multiple, it is hardly outrageous given the growth they are seeing.

Our earnings preview for Garmin (GRMN - Annual Report) said it “shouldn’t need a big surprise to move the stock from this level.” Today the company reported earnings:

First Quarter 2007 Financial highlights:

– Total revenue of $492 million, up 53% from $322 million in first quarter 2006

– Earnings per share increased 60% to $0.64 from $0.40 in first quarter 2006; excluding foreign exchange, EPS increased 37% to $0.59 from $0.43 in the same quarter in 2006.

These results compared to consensus expectations of $0.59 on $499 million in sales. So the stock did indeed move on a not-big surprise, albeit one in the opposite direction from which we implied. The company did not change its prior guidance, saying:

We remain optimistic about the future success of our business and our ability to serve customers and distributors around the world. We anticipate overall revenue to exceed $2.5 billion in 2007, and earnings per share to exceed $2.70 assuming an effective tax rate of approximately 13 percent. We anticipate automotive/mobile revenues to grow faster in 2007 than we earlier anticipated, and continue to expect declining operating margins due to product mix and a continued transition toward mass market levels. We intend to provide a formal update to our fiscal 2007 financial expectations during the Q2 2007 earnings conference call.

Unfortunately, analysts were already ahead of those expectations, calling for $2.81 in EPS on $2.54 billion in sales. Without a significant surprise in Q1 or a significant surprise forecast for Q2, the estimates are starting to look a bit out on a limb.

Add this data point to the ones provided by Royal Caribbean (RCL), Plantronics (PLT), Radio Shack (RSH) and Circuit City (CC) that consumer spending may be slowing.

The Economic Calendar has three potentially important events this week:

• Personal Income and Outlays on Monday (consensus 0.6% income, 0.5% spending)
• ISM Manufacturing on Tuesday (consensus 51)
• The Employment Situation on Friday (consensus 100,000 jobs added, 4.5% unemployment)

Earnings season continues in full force.

Monday

• Verizon (VZ - Annual Report) – possible upside to sales

Tuesday

• Plantronics (PLT) – anyone’s guess, though our long position gives away our own guess

Wednesday

• Cognizant (CTSH) – one of these days the growth will hit a wall, but probably not this day
• Garmin (GRMN - Annual Report) – shouldn’t need a big surprise to move the stock from this level
• Itron (ITRI) – risk to estimates in both directions due to Actaris acquisition
• Sprint (S - Annual Report) – the worst may be over here
• Symantec (SYMC) – Based on MFE and VDSL should have a big quarter

Thursday

• Ansys (ANSS) – Dassault beat big, and we like Ansys better
• QLogic (QLGC) – too risky for our tastes
• Starbucks (SBUX) – probably no surprise, but risk probably to the downside when they are making this kind of move

Disclosure: Long PLT and ITRI

Disclosure: Author is long Starbucks (SBUX) at time of publication.

We have been writing for several months that the success Garmin (GRMN - Annual Report) has had in the niche market of navigation devices is now attracting competition just as the market growth is really taking off. Judging by the reaction to their latest earnings report, investors are suddenly taking notice.

Garmin 3Q Profit Up 20 Pct, Stock Down: Financial News – Yahoo! Finance

While revenue rose 62 percent to $408 million from $251.3 million in the year-ago period, it missed analysts’ prediction of $423.4 million.

With most tech companies not posting anywhere near 62% revenue growth, one might think Garmin shares would be bouyed by the news. Instead, the shares plummeted 16%. Which illustrates a funny thing about Wall Street – sometimes it’s better for a company to post 8% growth when the consensus expects 9% than to post 62% when the consensus expects 63%, especially if rising competition results in both slower-than-expected sales and lower-than-expected margins. On the conference call, management had some discouraging words about margin:

Looking next at our margins by the virtue of four segments, our Q3 aviation gross margins declined from 66 to 64% as expected and our aviation operating margins declined 39 to 32% due to larger R&D costs as a percentage of sales. Our third quarter outdoor fitness gross margins declined from 60% to 56% due to unfavorable product mix and lower component costs reductions during the quarter….
Q3 marine gross margins declined from 60% to 53% due to unfavorable product mix and certain price changes as we anticipate new marine prices reduction in the upcoming months.

Our third quarter automobile gross margins remained flat at 42% for the third consecutive quarter beating our expectations….We do however expect that our automobile segment will experience declining operating margins due to reduced pricing and a continued transition toward mass-market level.

Clearly that wasn’t what investors wanted to hear.

We have written several times that navigation leader Garmin (GRMN - Annual Report) is in a tricky situation. It’s lucrative market segment, once dominated by itself and TomTom, is now lucrative enough to attract new competition.
The Pittsburgh Post-Gazette reports:

A new generation of navigation devices, designed to have the sleekness and portability of an iPod, are finding their way to store shelves this fall. The hand-held devices, which are being pushed by both traditional navigation-device makers like Garmin Ltd. and big personal-computer companies like Hewlett-Packard Co., are meant to be used by walkers as well as drivers. Meanwhile, cellphone companies are beefing up their own navigation services in an effort to capture the growing market.

Sprint, for example, is offering Garmin Mobile service for $9.99 per month. While Garmin gets a share of this recurring revenue, it is potentially losing customers for its stand-alone devices. While its P/E of 27x trailing earnings is not outrageous, any misstep would likely be punished.

When we last commented on Garmin (GRMN - Annual Report) we felt that potential market share losses, coupled with a consumer that seems to be getting tired, made it tough to justify the lofty price. Paul Kedrosky points out another potential concern:

So, is there a killer app for auto telematics? Short of broadband streaming (which would kill Sirius/XM/etc.), I’m increasingly convinced it’s realtime traffic — which makes Dash and Clear Channel Traffic Network (now used by BMW), among others, interesting stories. The fun thing is that many people I talk to think TomTom, Garmin, etc., have this nav market locked up; but it seems increasingly clear that the nav-centric incumbents don’t have as much as auto leverage as they (and their fans) think they do.

We share the opinion that navigation needs to be coupled with real-time traffic in order to be truly useful. However, it is not necessarily a deal-breaker for Garmin or the other leaders, as this Christian Science Monitor article points out:

As for navigating traffic, Magellan’s Roadmate has a feature that provides alternate driving directions via a color touch screen. The most recent Roadmate model also plays MP3s, has a photo viewer, and speaks driving directions. A suction cup keeps the 5-by-4 inch device in place on the windshield. The price ranges from $600 to $800 depending on the model, and excluding subscription fees. TomTom and Garmin offer similar products, with virtually identical prices.

Perhaps the greatest advantage of these devices is that they work in almost every major city across the country. That’s because, in the past five years, brands including Magellan, TomTom, and Garmin have partnered with major broadcasters to buy FM feeds that enable their devices to pick up traffic reports virtually anywhere. Coupled with technological improvements in mapping, these products are a lot more affordable than they were several years ago, says Brant Clark, a senior product planner at Magellan, the consumer brand of Thales Navigation in San Dimas, Calif.

This isn’t truly real-time traffic data, however. Although there is only a modest delay between the time the radio information is received and then re-broadcast to the navigator, any frequent commuter can tell you the larger delay is between the time the traffic forms and the radio stations learn of it. Still, any systems developed that would provide more timely data would likely be licensed to all of the navigation system makers in order to reach the broadest possible adoption.

Whether that justifies an enterprise value of more than 40x free cash flow is another story.

Normally by the time the big newswires pick up on a business story it has already run its course. Thus, we were surprised to see this mildly bearish take (in line with our own) on Garmin (GRMN - Annual Report) while the stock is still near its highs. The contrarian in us now wonders whether the story has more legs.
Garmin Tries to Navigate Mass Market: Financial News – Yahoo! Finance

As Garmin continues to move its products — and particularly its fast-growing line of automotive-GPS devices — into discount retailers like Wal-Mart Stores Inc. and Target Corp., prices will drop. The growing concern on Wall Street is that the retailing move will weaken Garmin’s profit margins.

“If Garmin chooses to cut prices, growth expectations may be met, but profitability is likely to suffer,” Bear Stearns analyst Peter Barry said. “If, on the other hand, Garmin sticks to their premium-pricing model, it is likely that its market share will erode.”

The GPS market, as analyst Barry noted, has swollen by 23 percent annually, totaling an estimated $23 billion in 2005. The car systems are thought to account for about one-third of the market.No surprise, then, that Garmin’s automotive division has become its star unit. In the latest quarter, its revenue soared 252 percent to $150.7 million. This year, Garmin expects to sell twice as many personal navigation devices as a year ago, and growth in the automotive division is seen reaching at least 75 percent.

Despite these encouraging statistics, some analysts worry how Garmin will fare as the auto market — now the source of nearly 50 percent of its revenue — becomes even more crowded. Garmin dominates with roughly one-half of the North American market, but faces challenges from a slew of overseas rivals, including TomTom NV of the Netherlands.

Of course, with TomTom’s recent stumble, it will be easier for Garmin to sustain its position.

Last week we reported on the earnings miss at digital navigation leader TomTom, which the company blamed on logistical issues.

TomTom declined to say which component had caused the problem, but added that it was a logistical mishap that could not be blamed on its Asian contract manufacturer or suppliers.

“We can’t blame any of this on Quanta <2382.TW>,” TomTom spokesman Taco Titulaer said, referring to its Asian contract manufacturer.

Now the story appears to be shifting.

Quanta Computer will lose its only client in the GPS market, TomTom, because of defects in the navigation devices the notebook maker has made for the Netherlands-based firm, according to the Chinese-language Commercial Times.

Anybody got some juicy low-down on this one? With holiday sales coming and Sony (SNE - Annual Report) and Pioneer joining the GPS fray, could TomTom be in more trouble than they let on?

We have written previously that increasing competition may make things tough for digital navigation leaders Garmin (GRMN - Annual Report) and Dutch rival TomTom (TOM2.AS) this holiday season. That concern assumed no significant other problems, such as those that have surfaced for TomTom:

TomTom shares slide after Q2 sales outlook | Reuters.com

Shares of Dutch car navigation firm TomTom fell sharply on Monday after the company said its second-quarter sales would be lower than expected, but some analysts said this was a good opportunity to buy into the stock.

Although the company maintained its full-year sales and profit margin target, other analysts put their estimates and recommendations under review. Shares in TomTom, which is Europe’s biggest producer of portable navigation devices for cars, fell 7 percent to 29.30 euros at 0943 GMT after earlier touching a low of 27.60.

The company said on Friday after the market closed that its second-quarter revenue would be limited to about 275 million euros ($352.1 million) due to problems with the supply of a component for its car navigation devices.

To be clear, product issues such as these could easily be short-term. The company could even make up for the lost sales by pushing them into the following quarter once the parts issue is resolved.

However, any shortage of TomTom products on the shelves will mark an opportunity for all those new rivals to take some market share. And with TomTom giving them an inch…

Garmin (GRMN - Annual Report) rival TomTom says Microsoft (MSFT - Annual Report) has not come calling, shares rise anyway.

Nobody Loves Qualcomm – GigaOm

Korea’s antics were good for gold.

Disclosure: Author is long STREETTRACKS GOLD (GLD) at time of publication.