2023-06-02 06:26:38 ET
Summary
- Smith & Wesson is a market-leading firearms company with strong margins, low debt, and impressive profitability, despite its volatile revenue trends.
- The company's latest results show improvements in top-line results above pre-pandemic levels, with a focus on the outdoor market and strong product reception.
- With a conservative price target of $13.5, Smith & Wesson offers a double-digit upside at its current valuation, making it an attractive investment for those who understand its cyclical nature.
Dear readers/followers,
Firearms remain a controversial investment for many investors. My own stance on them isn't as controversial as that. Smith & Wesson Brands ( SWBI ) was a minuscule "BUY" in my portfolio, and any company that outperforms the index deserves highlighting here - and that's what I'm going to do. Since my last article, the company has almost doubled the S&P500, even if that outperformance has been small in absolute terms.
Seeking Alpha SWBI (Seeking Alpha)
I invest in firearms companies - this is only one of the companies I look at, and since my last article, I've been a "BUY". The company does have some, let's call them drawbacks. Less than $600M in market cap is one. No S&P Credit rating. A relatively low yield.
But there are advantages and upsides as well, and I believe the company is poised to outperform here.
Let me show you why.
Smith & Wesson - More upside remains in firearms
This is a market-leading firearms company. When I say market-leading, I mean that in terms of margins and profitability, this is a very well-run company. With operating margins of nearly 15%, gross margins of close to 36%, and net margins of over 11%, this company is in the top 60-80th percentile in the aerospace/defense industry. The company has extremely low debt, no higher than 0.6x to EBITDA, and impressive interest coverage of over 40x. On an ROIC basis net of WACC, the company due to its very low debt is very impressively profitable when looking at its investments. And that is despite some of the volatile revenue trends this company encounters.
When I say volatile revenue trends, this goes to net income as well. During times of ups and downs, a company like SWBI experiences some real swings in income and cash flows.
Any investment in this company should be made with this cyclicality foremost in your mind. If you buy the company when it's cheap, maybe even when its revenues are actually negative, you can then hold onto the company until things go positive, and rake home returns in the triple digits. An example of this is between the 2020-2022 period, at which time you could have seen a TSR of 407% in less than 2 years, or annualized RoR of 276.02%.
So this company is volatile, yes. But the underlying operations - Smith & Wesson, a qualitative firearms manufacturer, that is I believe one of the better ones in the segment you can invest in. And even if the company experiences downturns, that'll hardly mean this company is headed for serious trouble. Not with its low debt, and not with it selling a product that is, in most contexts, timeless. Volatile, but timeless.
The latest results we have are 3Q23, given it's a different fiscal. The latest results include a decrease in sales, which is natural given the "top" it's had since 2021. This is likely to continue to decline for this fiscal. Gross margins are in decline as well. We could see almost 40% a year ago, now down to around 32.5%.
Despite these on-the-surface-negative results, we actually have good reason to be pleased with the company here. Top-line results are improving above pre-pandemic levels, which is what we're looking for here. Bottom-line are showing improvements and better levels as well, again above pre-pandemic levels. Look at the revenue trends above, and even without me going deeper into the specifics, you can see on the visual representation that the company is generating a very healthy amount of net profit based on revenues. Many of the usual Flower quarterly comments in this particular case actually make a decent amount of sense.
Our results reflect the work our team has done to capitalize on the opportunity afforded by our flexible manufacturing model during the surge to fundamentally transform our business model as it relates to product mix and pricing. Further, the firearm market remains healthy, with strong participation growth in recent years on top of a large and loyal base of core consumers, all of which leads to a compelling view of the future for a leading brand like Smith & Wesson."
(Source: SWBI quarterly results)
The company has improved by adapting to its flexible manufacturing model - and the various end markets, including sport, will likely ensure that trends continue for this company and its results continue to be positive.
Inflation? Yeah, it's an issue - but the company's average selling prices are once again, above the pre-pandemic numbers. At this time, anything above pre-pandemic is positive.
Remember, the company has relatively recently relocated to TN, which resulted in higher borrowing, but the company expects that it will be able to repay its balance by the time this relocation is complete, without leveraging up its healthy balance sheet to any particularly negative or worrying level.
Nothing will make this company a non-volatile business. The ups and downs will continue. Current estimates, including mine own, include continued pressures on both the top and bottom line, compressing margins and profit until we're seeing trends close to pre-pandemic levels, but still above them overall. I expect revenues to bottom around $500M for the 2023 period, before starting to rise again, around $540M to 2024, with corresponding increases in earnings as well.
We can also look at analyst estimates on a general level, which confirms the overall outlook of a slight decline, followed by stabilization in 2024E and potential forward.
As I've pointed out - this company is now with a large focus on the Outdoor crowd and appeal, and its manufacturing of handguns, long guns and ancillaries is likely to remain attractive both in an upcycle and a downcycle - that includes recessions, by the way. SWBI is notoriously recession-proof. Or rather, its ups and downs don't have much correlation to the overall macro. At best, it can be said that there's an inverse correlation. When the pandemic broke, SWBI's sales skyrocketed, as you can see above, with massive earnings boosts.
The fact that the company is recording lower OpEx is a testament to the relocation and the company's new model. The company reports the seasonal demand structure is intact, and inventories are normalizing. Cost pressures are not yet over - so we should expect the results to remain under pressure for the next 1-2 quarters, but I believe the "worst" is now behind the company, and we can look forward and expect longer-term improvements here - slow ones, but improvements nonetheless. the company recently launched the new 5.7, with excellent reception across various markets and users. The new model has a large capacity - 22 + 1, alongside the new tempo barrel system. I don't live in a geography where I can easily try this out, but I look forward to heading over to the States again and going to the range and trying out some of the new products that I've missed not being there for a while - since COVID-19 hit.
Let's look at the company valuation and why I remain positive on Smith & Wesson.
Smith & Wesson - Plenty to like about the price.
At a 15x P/E, the company has a double-digit upside to its 2024E results. We're already in fiscal 2023, with the 3Q23 now in the bag, so 2024 is not far off. This is not your traditional investment. While the company is not as cheap as when I loaded my position, I still believe it's cheap enough that someone who knows what they're buying can get a good deal.
SWBI yields over 3.4% which isn't bad, and that dividend is, as I see it, not going anywhere with the company's 2024E earnings expected to be at or around the level of the 2023 ones.
Just like other firearms manufacturers, this one remains volatile. Remember that. Forecasting it is hard, I would say risky enough that beyond general trends and stating that the company could be cheap for what it offers, is somewhat over-positive.
That's what I am stating here. I am saying that for what SWBI offers, I believe the company to be cheap at this time
General valuation targets put the company at around $15.2, which is well below the $20/share price target we saw a year ago. Of course, I never saw $20 as valid. My PT for the company has been $13.5 for as long as I've reviewed the company. That's where I believe the upside can be found, and I don't change my PT easily, especially not for a company in this segment or in this business.
There are only two obvious peers to SWBI. They are Ruger ( RGR ), which I also write about. You can also argue for Vista Outdoor ( VSTO ), to some degree/extent. Ruger is the closer one, and it's still more expensive than SWBI here by a fair margin, same as with my last article, with a higher P/E and a somewhat higher revenue multiple. Otherwise, as I mentioned early on, the company compares to Aerospace & Defense, or sport and outdoors, and in either segment, this matches up as favorable.
I would still use long-term sales and revenue/book multiples as an indicator of the overall attractiveness of the company, and at the current price being below my PT, these still look pretty good.
Remember, a business like SWBI is prone to exuberance during the company upcycles - but the downcycle targets remain solid. The company has shown impressive resilience despite what is essentially a negative YoY result - but the company is happy with those results, and I am as well. The reason here is that results are actually above what I would have expected the company to settle at post-relocation, inventory normalization, and out of COVID with all of the inflationary and labor pressures out there.
For that, the company is still doing well, and for that reason, I give the business the following PT of $13.5 at this time, and use the following thesis for June of 2023.
Thesis
- Like other firearms manufacturers such as Ruger, SWBI is a volatile and cyclical company with ups and lows but found in a fundamentally attractive segment in the US market. The company has no credit rating, but also extremely low debt, and produces products that are extremely unlikely to go anywhere in the short, medium, or long term, at least in the US market.
- I give the company a conservative PT of $13.5, which implies a double-digit upside at today's valuation. It's no longer significant, as the last article, but we're still at above 15% annually.
- The company should be considered cyclical, however, and you should look at what other potential investments are available to you at this particular time - because there are better ones out there.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
The company's flaw is its dividend. I won't consider it less than qualitative for the credit rating, because it's low debt. I consider it a "BUY" here, even if it's no longer cheap. It won't take much for this company to now go into a "HOLD" position for me.
For further details see:
Smith & Wesson Brands: We Have Slight Outperformance