Summary
- I've been writing about players in the firearms industry for a number of years, though mostly focused on one specific firm. Today, I'm going to look at Smith & Wesson.
- The company is the nation's (USA) largest firearms manufacturer found in Springfield, MA.
- SWBI is a market-leading company in a volatile sector - but it pays a dividend and is cheap. Here is my introductory thesis for the company.
Dear readers/Followers,
Firearms companies are somewhat of a volatile segment to invest in. They're also exposed to political realities, as well as overall macro. While the 10-year return of investing in Smith & Wesson ( SWBI ) is positive at over 50% ROR, it's not really market-beating. Instead, this is a segment to invest in once it's cheap, and one definitely to trim when the political macro goes into favor.
I've done so with some of the company's peers, and I expect to do so with this one if I do end up buying shares, which I haven't done yet as of writing this article.
Let's look at what Smith & Wesson can offer you.
Smith & Wesson - A legacy of firearms
The company was founded by Horace Smith and Daniel Wesson in the 19th century (1852) to develop the so-called Volcanic rifle, also coming with a patented cartridge in 1854. It was quickly renamed Volcanic Repeating Arms, and bought out by Winchester, and renamed, following insolvency, into Winchester Repeating arms. The two founders also, at roughly the same time, acquired employees and know-how from Samuel Colt's revolver business (where the patent was set to expire), and the two formed the Smith & Wesson Revolver Company. Rather than the rifle business, this was to be the modern Smith & Wesson.
The company saw massive demand during the Civil War, and the ongoing conflicts from world wars to post-war periods of innovation, were very successful for the company. SWBI developed the .357 Magnum, and it's fair to call the company's high point around 1955, when they created the Smith & Wesson Model 29, in .44 Magnum, which became a cultural icon through movies like the "Dirty Harry" franchise.
The Wesson family actually sold its controlling interest in the business to Bangor Punta in 1965, which lead to significant diversification in the civilian sector, including sales of holsters and ancillary law enforcement products, like handcuffs and breathalyzers. This move eventually made SWBI a market-leader, and competitors tried mimicking this for a long time.
However, the 1980s saw a decline in sales. The war on drugs took its toll with most US police departments replacing their more powerful Smith & Wesson with semi-automatic European-made Glocks, Sig Sauers, and Berettas, and in less than 4 years to 1986, company profits fell by over 40%.
This led to SWBI being bought again, this time by Tomkins PLC, for a sum of $112.5M, leading to increased production quality. However, lawsuits and bans made sales sluggish, and in 2001, Saf-T-Hammer bought the company for $15M. Compare this to the inflation-adjusted 1987 price, and you'll realize what a fraction of the price we're talking about here.
In an era of school shootings and more scrutiny, SWBI countered with marketing to big box retailers, and on its products as an Outdoor appeal. The company never really stopped being volatile - as these companies never stop being overall, and going out of the worst of the Pandemic, SWBI had a market cap of around $880M, with the ability to generate annual sales of around $1B.
The latest set of years are a very good example of just how volatile things can be in this segment. 2021 saw an adjusted EPS increase of 929%, 2023E is expected to drop around 80%. In 2018, EPS dropped 92%, only to rise 80% the year after. Stability is not what this business is known for.
The company has no institutional credit rating worth mentioning. it currently pays a yield of around 3.7%, but this is not to be seen as indicative, because the company has only paid a dividend for 2 out of the past 18 years.
The company has extremely conservative debt - less than 10% of debt/cap, though this is once again somewhat inflated by the current numbers, which should be seen as non-recurring or at the very least extraordinary (meaning "not ordinary").
The company currently, as of FY21, manufactures:
- Handguns, such as revolvers and pistols
- Long Guns, including modern sporting rifles
- Ancillary products, such as handcuffs, suppressors and firearms VAP products
The products are sold to a wide variety of customers, including enthusiasts, collectors, hunters, sportsmen, competitive shooters, people protecting their homes, law enforcement, security agencies, and military agencies.
Company products are sold through one of three brands - Smith & Wesson, M&P, and Gemtech.
All of the company's products are manufactured in the USA, with facilities in Springfield, Houlton, and Deep River. The company has one distribution center found in Columbia, Missouri.
Being a premier and market-leading firearms company, SWBI also sells its services as a manufacturer to other brands to level-load its factories and bump utilization rates, which are services found under the Smith & Wesson and Smith & Wesson Precision Components brands.
To exemplify how the company is innovating its products and developing improvements, the company introduced the first Smith & Wesson Shotgun in over 20 years now in the 2022 fiscal, the M&P 12. The company also introduced the Volunteer Rifle series and a new set of 10mm caliber to its M&P 2.0 line of polymer-based firearms (pistols). SWBI also developed and introduced new suppressors.
Sales splits are interesting. The top-5 commercial distributors account for a total of 44.3% of sales - and this is a figure that's increasing, not declining. However, the company believes that any loss of one of these would be picked up by the remaining 4, as sales are not regionally exclusive and many of their customers are the same.
International sales are very modest - only 3% of total. The company combines modern digital marketing with very classic strategies, including outdoor and firearms magazines, as well as sponsoring firearms safety, shooting, and hunting organizations.
The underperformance is relatively easy to be seen here.
The company takes revenues of around a billion ($864M in 2022, from which it earns gross margins of around 39-45% (44.5% in 2022), down through operating expenses and generating an impressive margin of around 30%. However, the OM is part of where the instability comes in, because in 2018, that margin was as low as 4.5%. When things crater, they do crater significantly.
Still, SWBI is not unique in this in its peer group, and it's consistently able to pull off net profit and positive EPS over time, as well as consistent positive EBITDA over time.
The 2Q23 fiscal was reported back in December. The results back then weren't as good as expected, and the company's share price responded by dropping around 7%, mostly due to significant impacts in the gross margins, which dropped to near multi-year lows of 32.4%, even though this was mostly higher than the quarterly numbers seen during the worst of COVID-19.
The company is in a normalization phase in terms of sales, and the normalization continues. A combination of cyclical trends, inflation and input costs, wage increases and the like are all straining the company's finances. The company also moved to Tennessee, which saw some non-recurring costs influencing the company's quarterly numbers.
The picture that the company wants to convey is normalization at a somewhat higher level than historical demand levels, and overall, I believe this to be a fair picture to give. The industry is cyclical and by removing share price and valuation from some of the numbers and graphs, we get this.
Again, not exactly stable - but a business of this sort isn't really known for its stability. The right time to buy the company can easily be guessed by looking at trends like these.
Smith & Wesson is a qualitative business in, as I see it, a sector that's not going away in the USA. While non-US markets remain trivial aside from the military and law enforcement segments, this company remains a company to be counted upon specifically in the US market. It has a loyal following, great products, and impressive innovation.
If the market undervalues this business, I see no reason why you would be unable to generate alpha from this investment.
Let's look at the company valuation.
Smith & Wesson Valuation
Evaluating a company such as this is relatively tricky. Cyclicality is a serious issue here. SWBI trades at a NTM-based P/E of 11.5x at this time, a revenue multiple of around 1x, and sales of around 1x. The company's historical multiples are heavily distorted from 2021 and 2022 and need to be normalized over a far longer period in order to avoid being over-ambitious of the potential of the business.
Current forecasts from S&P Global call for SWBI to face a very tough 2023 fiscal drop, followed by slight growth in 2024. There is no dividend forecast here, despite the fact that the company currently does pay a dividend.
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 actually more expensive than SWBI here by a fair margin, with 4.5x higher P/E and a 0.5x higher revenue multiple, as well as over 1x more in terms of next-twelve-months EBITDA. The comparison to VSTO is more or less at similar levels.
The number of analysts following SWBI is low - only 3 S&P Global analysts have a target for the business, though these analysts have followed the company for years. Their target range begins at $12 and goes to $20. The average at this time is $15.17, and that's down from almost $30/share a year back or so. 2 out of 3 analysts are currently at a "BUY", and they see an average upside of 40.3%. I do not - I believe this is being too positive on a cyclical and volatile business with no credit rating and only a modest yield with zero safety or real forecastability. DCF modeling is not, as I see it, relevantly applicable to SWBI due to their extreme highs and lows, and what it does to the company's share price.
Peer averages and trying to catch the company at an excessive, low multiple is the best way I see to make a decent profit on Smith & Wesson as an investment. One of the more common mistakes I see is loyal customers of a company mistaking that same company to be a good investment financially. This is not the case, I would go so far as to say that it might often not be the case.
I would use the long-term sales and revenue/book multiples as an indicator of the overall attractiveness of the company. And as things stand now, these are looking fairly good.
I would also look at peers to make sure we're not paying too much - and as it stands now, we are not. While I believe the analysts for SWBI are prone to exuberance during upcycles, I believe their downcycle targets are relatively solid. At current valuations, the company is somewhat undervalued, and I would give a PT of $13.5/share for the company, resulting in a double-digit upside. The big question is how the company's share price will trade in an environment where for the next 2 fiscals at least, the company seems likely to produce significantly negative YoY results.
For that reason, the following is my thesis on Smith & Wesson.
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 significant double-digit upside at today's valuation.
- 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 its low debt. I consider it a "BUY" here.
For further details see:
Smith & Wesson: Potentially Better Than Peers