Smith & Wesson: A Worst Case Scenario

| About: Smith & (SWHC)

I've previously posted my fair value calculation of Smith & Wesson (NASDAQ:SWHC) (see: Smith & Wesson is a Buy) assuming the company would continue business as usual. Due to the abundant national attention surrounding an assault weapons ban, I feel it's prudent to re-tool my analysis of SWHC and project a potential worst-case scenario. This article seeks to clarify 3 questions I find imperative for my thesis on Smith & Wesson:

  1. How probable is an assault weapons ban?
  2. What is the long term growth rate of gun sales?
  3. What impact would an "Assault Weapons Ban" have on the share price of SWHC?

How probable is an assault weapons ban?

Let's start with the bad news. The following is taken directly from Senator Feinstein's website and highlights the key points of her proposed legislation:

"The legislation bans the sale, transfer, manufacturing and importation of:

  1. All semiautomatic rifles that can accept a detachable magazine and have at least one military feature: pistol grip; forward grip; folding, telescoping, or detachable stock; grenade launcher or rocket launcher; barrel shroud; or threaded barrel.

  2. All semiautomatic pistols that can accept a detachable magazine and have at least one military feature: threaded barrel; second pistol grip; barrel shroud; capacity to accept a detachable magazine at some location outside of the pistol grip; or semiautomatic version of an automatic firearm.

  3. All semiautomatic rifles and handguns that have a fixed magazine with the capacity to accept more than 10 rounds.

  4. All semiautomatic shotguns that have a folding, telescoping, or detachable stock; pistol grip; fixed magazine with the capacity to accept more than 5 rounds; ability to accept a detachable magazine; forward grip; grenade launcher or rocket launcher; or shotgun with a revolving cylinder.

  5. All ammunition feeding devices (magazines, strips, and drums) capable of accepting more than 10 rounds.

  6. 157 specifically-named firearms"

Sounds ominous for gun companies such as Smith & Wesson and Sturm, Ruger & Co (NYSE:RGR) but I believe the proposed legislation faces serious Congressional headwinds. In addition to the Republican-controlled House of Representatives the bill has left plenty of Democrats feeling uneasy. For example, Senators Max Baucus (D-Montana), Mark Begich (D-Alaska) and Mark Pryor (D-Arkansas) are all running for re-election in 2014 in their respective "gun enthusiasts" states and have balked at the legislation. Additionally, Senator Heidi Heitkamp (D-North Dakota) has labeled the legislation "extreme" and Senate Majority Leader Harry Reid (D-Nevada) has yet to endorse the bill and voted no to expand an assault weapons ban for national parks in 2009.

I believe a watered-down version of the Feinstein bill is more probable, although it is hard to ignore the impact on Smith & Wesson if such a ban were to take place. My worst-case scenario assumes legislation is passed after April of next year - the beginning of Smith & Wesson's fiscal year 2015.

What is the long-term growth rate in gun sales?

Obviously, the current gun buying frenzy is unsustainable. It has been widely documented that applications for gun permits are at all time highs and backlogs of orders are at record breaking levels. As of October 2012, SWHC had a sales backlog of $332.7M vs $149.9M one year earlier. The following is taken from SWHC's Investor Conference held December 6:

While backlogs records are relevant for short-term sales sustainability, I've included the following chart to get a better idea of the long-term growth projections in gun sales. It clearly shows a long term upward trend and sales growth projections have averaged 5.25% and 4.25% per year for handguns and long guns respectively:

Click to enlarge
(Click to enlarge)

The trend in guns sales is similar to the trend in consumer discretionary and should continue to follow the GDP, regardless of an assault weapons ban. In my analysis, I've assumed the longer term growth rate of 4.75% (an average of long guns and hand guns growth projections over the last 30 years).

If the ban were to go into place, what would be the impact of SWHC shares?

As of the most recent quarter, Modern Sporting Rifles (targeted in legislation) represent 24% of SWHC's sales. Below is data gathered from their most recent 10-Q (as of October 31 2012)




% YoY increase

% of Sales







Modern Sporting Rifles






Hunting Firearms












Parts & Accessories










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Astonishingly, Modern Sporting Rifles had a 119% increase from the same quarter a year earlier. So what if sales of Modern Sporting Rifles were to end entirely? Analysts at Wedbush Securities estimate an assault weapons ban would take .40 off earnings per share. Smith & Wesson's fiscal year ends in April and my worst-case projections assume they match Street earnings estimates of $1.04 a share this year and $0.94 next year before falling precipitously in FY15 after the assault weapons ban takes effect, before resuming a long-term growth rate of 4.75%.




Terminal Year






- (CapEx-Depreciation)*(1-DR)





-Chg. Working Capital*(1-DR)





Free Cashflow to Equity





Present Value




Growth Rate in Stable Phase =


FCFE in Stable Phase =


Cost of Equity in Stable Phase =


Price at the end of growth phase =


Present Value of FCFE in high growth phase =


Present Value of Terminal Price =


Value of the stock =


Click to enlarge

SWHC closed Friday at $9.21


Even with an abundance of uncertainty surrounding gun manufacturers, SWHC still trades at a discount to a potential worst-case scenario. While nobody can predict the future, I believe risk/reward favors the upside in 2013.

Disclosure: I am long SWHC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.