I’ve written previously about Smith & Wesson (SWHC soon to be AOBC), and recently increased my position after the post-earnings downturn.
Investors thought guidance was disappointing which combined with short interest of >20% resulted in a major post earnings sell-off of ~10%. People are worried about gun sales declining, but that bogeyman hasn’t actually materialized yet. The FBI reported record NICS applications for the month of November.
(Some) fear is warranted. Gun sales can be volatile. There should be no question in the minds of investors that 2017 and 2018 will likely be tougher years for SWHC given the likely demand which was pulled forward into the election cycle. When gun sales do decline revenue can decline by as much as 50%. I don’t believe that this is a likely scenario.
Additionally, management intends to continue bolt-on acquisitions which could result in higher revenues, but lower margins. In spite of these potential headwinds, I think SWHC is one of the safest stocks selling in the market currently on a valuation basis. The risk/reward profile is too favorable for patient investors to ignore.
Ibn Khaldun’s “asabiyah” in the U.S. is very low -in my opinion- due to a general lack of trust. Gallup’s well known confidence in government institutions poll is also at record lows. From my reading of Peter Turchin’s War and Peace and War, this is highly unlikely to improve under Trump, perhaps even unstoppable without some sort of credible external pressure to the homeland which forces U.S. citizens to coalesce ie: a China, Russia hegemonic threat. Now major new sources are advocating for the liberal purchase of guns due to fear of Trump apparently??
Revenue guidance is up 90% y/y. EPS guide up 93% y/y, free cash flow continues to grow in time with EPS. So I don’t think gun sales are going to fall off the rails entirely, though we could see a 10-30% post-election pinch in revenue as excess inventory buildup gets removed. Ultimately I think SWHC can look past any short-term demand concerns. The stock is a valuation hedge at these market levels and tends to react inversely to the stock market as a whole.
- 7x Price/Free Cash Flow
- 5x EBITDA/EV
- PEG of 0.5-0.7
- Debt to Equity of 0.52
Applying a 30% reduction in revenue to these metrics still yields a fairly valued stock.One could argue that this unproven bearish outlook is already baked into the share price. While Joel Greenblatt’s Magic Formula is far from perfect, it is also worth noting that both SWHC and RGR are currently on the list.
Furthermore Smith & Wesson currently pays a tax rate north of 30%. A 15% tax rate on the most recent quarterly earnings would have resulted in EPS of 0.74 vs the actual 0.57.
Short interest of >20% of the float also leaves room for a short-squeeze, and the company has a great CEO who has a history of well-timed buybacks. Additionally, SWHC guidance is always conservative and usually beats estimates.
The long-term trends behind lack of institutional trust and growing interest in concealed carry are powerful drivers. In the aggregate, overblown concerns about gun sales, an attractive valuation, potential tax rate reductions, and solid management all point to the potential for share price appreciation over the next year.
For the reasons above, I believe SWHC (new ticker AOBC in the coming months) has a compelling margin of safety relative to the market, with upside optionality from better-than-expected gun sales and/or a significantly lower tax rate within the next two years.