Adding to Smith & Wesson

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.


Author: secondhandstocks

The genesis for this blog stems from a Marine buddy and I came back from Afghanistan with more money than knowledge, and heedlessly tossed our hats into the stock market ring. A few months later, I remember discovering the classic book The Intelligent Investor by Graham and Dodd, and ravenously devouring my first introduction to value investing. That framework - with some generous additions by Seth Klarman, and Joel Greenblatt among others - guides my investment philosophy. I spent five years working in the intelligence field, both in the Marine Corps and then for a government agency after that. I speak Arabic and Pashto, have programming and analysis experience, and enjoy investing in technology companies as a hobby. I also spent a year on Wall Street working on a #1 Ranked Institutional Investor team, before deciding that that the Sell-Side was not for me.

3 thoughts on “Adding to Smith & Wesson”

  1. I don’t like the name change for Smith & Wesson. I think that is a poor move, albeit a small one, that will have a greater impact than expected. For the respect that the name Smith & Wesson garners, I don’t think it is unfair to comparing it to a name change for other well known household names, luxury brands, or industrial icons. Brand names are so important in consumerism. Personally I would rather have Smith & Wesson branded outdoor gear than “American Outdoor” products. It is completely superficial, but much of consumerism is based on superficiality.

    1. Thanks for the comment!

      I get that argument, but would management be dumb enough to rebrand the actual guns? I think this is simply a corporate name change, in which case the impact to the pistol brand should be non-existent. Am I missing something?

      1. No you’re not. They are not rebranding the guns. My point is I would rather buy Smith & Wesson outdoor equipment and accessories than a generic brand name that no one knows. And I think that notion would be common among customers. I personally own Smith & Wesson branded defense and accessory equipment. So I would personally rather it stay that way from a consumer perspective and from a stockholder perspective. If it is simply a corporate name change with no affect to branding then this is all irrelevant I suppose.

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