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Morningstar | Garmin 2Q Results Beat Expectations; Increasing FVE to $62; Shares Remain Fairly Valued. See Updated Analyst Note from 01 Aug 2018

Garmin reported second quarter 2018 results with the top and bottom lines coming in ahead of expectations, with ongoing strength in aviation accompanied by growth acceleration in the marine segment.  Management increased its full-year 2018 guidance. We slightly upped our 2018 revenue estimates, which combined with a lower effective tax rate assumption pushed our fair valued estimate of Garmin to $62 per share, from $61. Impressive performance in marine and aviation segments during the quarter support our thesis that the growth at these narrow-moat segments will more than offset the decline in auto’s PND business and will help the company continue to generate eYiesxcess returns on capital. The stock went up 3% in reaction to the better-than-expected results.  With shares still trading in 3-star territory, we recommend waiting for a wider margin of safety before allocating capital to narrow moat and high uncertainty Garmin.

Total revenue increased nearly 10% from last year to $894 million as the surprisingly strong performance of the no-moat fitness segment continued for the second straight quarter as it grew 24% year-over-year. This more than offset the mere 4% growth seen in the narrow-moat outdoor segment. However, we note that outdoor had some tough comps as it launched the well-performing felix 5 products in second-quarter 2017. In addition, the outdoor business remains one of the top Garmin segments in gross and operating margin.

Aviation revenue grew 23% year over year to $153 million as the segment continues to benefit from adoption of Automatic Dependent Surveillance-Broadcast, or ADS-B, which helps more easily and quickly track planes using satellites to broadcast their position rather than radar, which may not allow planes to fly as directly from one location to another. The FAA requires planes to be ADS-B enabled by January 2020. While nearly half of the planes with an ADS-B requirement remain to be equipped (according to Garmin), we note that growth in Garmin aviation revenue, which recently has been on the back of more Garmin ADS-B solutions being deployed, is likely to decelerate beginning in 2020. However, as more Garmin ADS-B solutions are being used, there will likely be more switching costs, which we have long viewed as one of Garmin's aviation moat sources. For this reason, while we may see slower growth in aviation post 2019, we believe the firm is well-positioned to cross-sell other aviation products, thus strengthening switching costs and possibly creating further barriers to entry.

While about half of the 24% year-over-year marine segment revenue growth came from the firm’s acquisition of Navionics in late 2017, we were impressed by the segment's 12% organic growth. According to management, LiveScope (a tool to locate and display fish swimming within 200 feet of boats), which was launched in the quarter, drove most of the growth. We expect strong growth in this segment to continue as revenue from the exclusive agreement with Sportsman Boats (announced in June 2018) will likely be recognized starting in late the third quarter.

On the margin front, the firm's higher SG&A and R&D spending offset the strong top-line growth that resulted in an operating margin of 24.3%, down only 60 basis points from last year. We expect advertising and SG&A cost control in the seasonally slower third quarter, which will likely help the firm post a 90-basis-point operating margin expansion in 2018.