Smith and Wesson Holding Corporation

This is something I worked on about 2 months ago. This was before we saw a rather significant decline, and then a 18% jump in share price after significantly beating earnings. I believe the continued short term success shown by SWHC is indicative of a company which will continue to do well long-term and will continue to take up market share.

Smith and Wesson Holding Corporation (SWHC)

1/27/14

 $13.21 per share

P/E 9.40 – EPS 1.40

Smith & Wesson Holding Corporation is a situation that has all the attributes for a great investment. The industry is riding an incredible growth trend, barriers to entry are very high, management is highly capable, valuation multiples are great, and S&W is seizing all of the fastest growing segments within the firearms industry. Some highlights:

  • S&W has CAGR of 15.6% over the last 6 years. Operating margins have grown from 10% to almost 23% in that same time.
  • U.S. consumer firearm market has grown at a CAGR of 12% from 2005-2011 (ATF)
  • S&W has grown to a 17% domestic market share and is continuing to grow in newer, faster growing segments such as the modern sporting rifle, where they hold 20% market share.
  • Projected fiscal growth is on target to be 26.7% and through Q2, they have seen 33% growth in guns shipped.
  • The company just completed a $100mm stock buy-back and has authorized another $15mm buy-back for fiscal 2014. This represents another 0.083% of the current equity capitalization.
  • Management is relatively new and is duly incentivized with S&W’s strong “pay-for-performance” philosophy. Management is required to hold 3x (CEO) and 2x (rest of C-suite and upper level management) base salary in common stock within the company, and is compensated with stock options per the company’s success.

The bear case revolves around two questions: Aren’t we on the end of a political buying frenzy? Is growth simply an effect of the Obama induced gun craze? The media paints the picture that a fear of re-regulation is the driving force behind the firearms industry growth. There are over 6.2 million shares sold short and the short percentage of float is 11.08%. My research indicates a consensus misperception of industry outlook. S&W has not seen its share price rise in line with its stunning earnings report and is still trading at very low multiples while margins are continuing to increase. FBI NICS background checks since 2006 (pre-Obama) have seen CAGR of 11.3%. I do not think this is in line with a short-term gun fad.

  • EV/EBITDA – 4.68 – This multiple is indicative of a market consensus that says this growth is not sustainable short/medium term, but does not account for long term ability from S&W.

Smith and Wesson’s Fiscal 2014 Q2 gross margins were 42.1% and handgun growth was 27% with a cash balance of $52.9mm. This shows us that although many bears believe the fear driven gun buying phase is over, S&W continues to see large growth, even in the short term amidst doubt and fear.

Management has talked about the continuing risk factor that demand is much too high for what S&W can currently produce, however management has recently put into place facilities upgrades that would make S&W capable of meeting such high domestic firearms demands. Management has financed this decision of growth cap ex with approximately $50mm in debt, however the company is strong enough financially to remain ending balance of net cash at $100.49mm. Although this cap ex growth strategy will depress results in the intermediate term, capacity expansion will increase earnings power

Risks

  • The Obama administration successfully implements major anti-gun restrictions, which although creating a major buying frenzy in the short term, would hurt long term results as well as eliminate major market share growth.
  • The “politically driven gun phase” thesis is correct and S&W continues to move lower amid very low multiples.
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