Over the past twelve months, Garmin (NYSE: GRMN) saw 6% of shareholder value wiped out while the broader S&P 500 market rose 18% and Apple (AAPL) gained almost 50%. This is particularly surprising given that Garmin grew revenue nearly 20% year-on-year to around $5 billion, driven by strong double-digit returns across all segments. While Garmin is well known for its GPS devices, it has underappreciated potential in wearable technology (think electronic watch) and fitness apps. Although Apple is the leader in handheld technology, Garmin is poised to further penetrate the wearable space. At 17.5x forward earnings, a 2.3% dividend yield and healthy gross margins of 58%, on the face of it, it’s a value play against Apple, which is trading at 26.6x with only 43% gross margin. The margins between the two aren’t exactly comparable, but the fact that Garmin is able to generate higher gross margins than Apple certainly speaks volumes about the quality of its products in the market.

According to data from Seeking Alpha, the street is generally bullish on the stock. Nearly 75% rate the stock as a “buy” or a “strong buy”. This sentiment is considerably more bullish than in June 2020, when just 25% placed the stock in “buy” territory. Some of the shifting optimism has to do with strong tailwinds in smartwatches and the “better for you” fitness economy. Fourth quarter results were much better than expected due to strong margins and the company handled supply chain challenges better than many others. Revenue CAGR since 4Q2019 is 12%, reflecting a company with strong fundamentals despite the updated valuation. Management now expects 20% year-on-year growth in 2022 for Outdoor, with significant traction in adventure watches

DCF analysis indicates a significant advantage

To get an idea of ​​the intrinsic value of the company, I performed a DCF analysis. No DCF analysis can provide a perfect picture of future shareholder returns; however, they can provide an illustrative “story” of the likelihood of different scenarios. In my DCF analysis, I assumed revenue growth of 10% in 2022, increasing to 5% by 2026. I also assumed that EBIT margins would increase slightly by 200 basis points over the next five years. . Capital expenditures, increase in net working capital, depreciation and taxes have been stabilized for simplicity.

Assuming a terminal EBITDA multiple of 12x and a discount rate of 7%, the stock is slightly undervalued. As much as I’d like the stock to be undervalued to call it a “true” value play, the truth is that value is hard to come by in today’s market, period. So at this point I find it attractive to just invest in a company that is not materially overvalued. It’s important to note that Garmin’s multiple has varied significantly over the past 15 years, from 8x to 15x, so the 12x estimate I’m using is within range.

Looking at the sensitivity analysis, things look rosier. Even if the stock were to contract down to 10x and growth stalled at 3% GDP levels, there’s a 20% drop here, which isn’t too worrying given that this assumes “the worst” and is offset by the 7% annual returns inherent in the discount rate. If the stock were to grow at an 11% pace and see its multiple contract to 13x from the current level of 16x, the stock would be overvalued by 30%. As a result, I think Garmin has a very favorable risk/reward ratio.

Top Catalysts

There are several catalysts that could lead Garmin to reduce its discount to its intrinsic value. First, supply chain decongestion is essential. The availability of electronic components makes it a difficult environment for everyone, although I suspect the market is pricing this cyclical issue too much into long-term forecasts. Fortunately, Garmin has a vertically integrated footprint that it can leverage to navigate the supply chain more nimbly than some of its competitors. Second, I’m also optimistic about the company’s Lily smartwatch product and the launch of the all-new Instinct 2 series in two sizes. Demand for Garmin’s smartwatches has been strong so far, and I think it’s well positioned to gain more market share and eat away at Fitbit and Apple’s iWatch. In general, Garmin’s Outdoor segment is benefiting from the centuries-old shift towards healthier lifestyles (or at least, attempts). The pandemic has sparked a lot of interest in active lifestyles and working out, and I anticipate this trend will only continue to grow.

I’m also extremely optimistic about the company’s automotive position. Annual sales increased by 26% last year and every year more and more cars are equipped with Garmin technology. BMW recently unveiled its vision for in-car entertainment, where Garmin will begin production later this year before ramping up significantly in 2023.

Why can I be wrong

Several factors temper my optimism. First, in the current craze for mega-cap technologies, it will be difficult for Garmin to attract much attention even if it has fired on all cylinders. The fierce competition in the smartwatch space is also hampering the ability to anticipate revenue growth. Management also said it was looking to raise prices; given the competition, this will not necessarily be a “tick the box” exercise. Finally, while the company’s long-term potential in automotive looks promising, the short term will be challenging given that it comes with lower margins. Given that much of the stock’s appeal lies in its margins, it is therefore ironic that the catalyst for strong growth adds an unfavorable compositional change from this point of view. Finally, there could be a stronger-than-expected pullback in demand for cycling products as pandemic-fueled demand cools.

Conclusion

Truly undervalued stocks are hard to find in today’s market. Nonetheless, Garmin stands out as a growth play at a reasonable valuation with a significant bullish history. With a shareholder-friendly capital allocation policy and strong secular tailwinds in wearable technology, Garmin is well positioned to leverage its vertical integration to generate outsized returns. The stock’s underperformance relative to the wider market is irrelevant given that operational execution has generally been solid, margins remain strong and growth opportunities continue to prove to be exploitable. With the return of big outdoor events like half marathons and 10Ks, you can expect to find a resurgence in Garmin products, which comes from a few innovative launches. So while Apple may continue to maintain the market-leading perception, Garmin’s products remain high-end and poised for future outperformance.