Can navigation devices maker Garmin ( GRMN) maintain its torrid pace?

The company, which reports its third-quarter earnings Wednesday, scorched analyst expectations in the second quarter when it posted earnings of $1 a share against estimates of 74 cents.

Garmin's stock is up 43.5% in the three months since July 30 and up nearly 120% this year. Currently its shares are hovering near the 52-week high of $125.68. The stock was down $1.20, or 0.9%, to $122.57 in recent trading.

Despite fears of a slow summer, analysts expect Garmin to beat the Street's third-quarter expectations because of increased demand for personal navigation devices, strong growth in the company's market share in the U.S. and Europe, and a slower-than-expected decline in the gross margin for its products.

Analysts polled by Thomson Financial expect earnings of 81 cents a share on revenue of $683.17 million for the quarter. The company posted earnings of 50 cents a share on revenue of $408 million a year ago.

Looking ahead, analysts estimate fourth-quarter earnings of $1.01 a share, up from 87 cents a year ago. They predict revenue of $986.38 million, up significantly from $611.22 in fiscal 2006. For the fiscal year, analysts expect revenue of $2.9 billion and an EPS of $3.42.

Analysts will also focus on Garmin's expectations for the holiday sales season.

Garmin makes GPS-based navigation devices for cars, motorcycles, aviation and fitness equipment, and that market for consumer-targeted navigation products is hot.

Personal navigation devices shipments are estimated to grow fourfold from 2006 and reach worldwide revenue of $16.5 billion in 2013, according to research firm iSuppli. TomTom, which is based in Amsterdam, Netherlands, is the global market leader with about 37% market share, followed by Garmin at 25%. Garmin is the industry leader in the U.S.

Even with expectations for a strong third quarter, the stock's rich valuation has worried some portfolio managers, including Joe Biondo Jr., chief investment officer for Biondo Investment Advisors.

"Garmin has been one of our better holdings this year but going into earnings I am a little bit less aggressive than I have been in the past," says Biondo.

Biondo estimates Garmin will report earnings of $4 to $4.50 a share for fiscal 2008 (Analysts polled by Thomson Financial expects EPS of $4.07). That means at today's price, Garmin is trading at least 30 times next year's numbers, he says.

"I will continue to own the stock but I have trimmed it back over the past month because of the appreciation," says Biondo. "The risk-reward ratio is getting less attractive now."

Analysts and managers will be watching gross margins, which could become an issue for the company as it faces increased competition and falling prices in the personal navigation devices market.

"The problem with Garmin -- as well run and promising as it is -- is that at the end of the day they are a hardware company and over time hardware margins start to decrease," says Biondo. "They can make up in volume but when margins start to decrease you see a compression in growth of earnings."

Rival TomTom's third-quarter results, which were reported Oct. 24, could offer some clues to Garmin's third-quarter margin numbers.

TomTom's average selling price for its products declined, but its gross margins improved sequentially from the second to third quarter, from 45% to 49%.

Peter Barry, an analyst with Bear Stearns, says Garmin might report similar results. "We attribute Garmin's better-than-expected gross margin to lower chip and map costs and believe it will benefit from these industry-wide cost dynamics," Barry told clients in a research note. Bear Stearns makes a market in Garmin shares.

Garmin also faces increased competition in a rapidly changing industry. In July, TomTom offered to buy main mapping supplier Tele Atlas for $2.5 billion, while cell phone maker Nokia ( NOK) offered $8.1 billion in October for mapping firm Navteq.The Nokia deal is expected to close in the first quarter of 2008, while it's unclear when TomTom's TeleAtlas deal will close.

So far, Garmin has responded to these large deals with a string of distributor acquisitions in Europe. Mike Ippoliti, research director in telematics & automotive for independent firm ABI Research, says the moves will strengthen operations but are unlikely to help the company battle the larger market shifts.

"Buying all their distributors will help them make more short-term money but it is not a forward-looking strategy," he says. "The question is do they simply want to maximize their profit while they can or is there a bigger long-term plan?"

Still, Biondo says valuation and long-term strategy concerns aside, Garmin's fundamentals are strong and the company will see healthy growth in the next few quarters.

"In a few years, every car is going to have a GPS system so there's plenty of room for Garmin to go," he says.

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