Smith & Wesson Beats Estimates, Raises Guidance, But Investors Still Aren't Happy

| About: Smith & (SWHC)

It turns out that Smith & Wesson (NASDAQ:SWHC) had another great quarter. The company earned $0.26 per share whereas the analysts were expecting it to earn $0.23 per share. It generated $136 million in revenues whereas the analysts were expecting it to generate $133 million. Furthermore, the company announced that it would generate around $170 million in revenues and $0.39 in profits in the next quarter, whereas the analysts were looking at $155 million in revenues and $0.30 in profits. For the full year, the company upped its earnings guidance from $1.00 to $1.19, which is amazing for the investors. Yet, the stock price was down by 2% in the after-hours.

Smith & Wesson's quarterly results reflect a 300% growth in earnings and 39% in revenues compared to the same quarter a year ago. This is simply amazing at a time when many people were bearish on gun companies because of a possible government crackdown on assault weapons. In fact, these speculations helped the demand side rather than to hurt it, which created a huge backlog for most gun companies. The backlog guarantees revenues for the next several quarters, even in the absence of any new orders. In fact, during the conference call, the company announced that the current backlog reflected sales of an entire year as of the end of the last quarter.

The company's flagship product M&P polymer pistol is seeing tremendous demand, whereas its highly diversified portfolio allows it to continue to see growth in the event that any particular type of weapon is banned or certain limitations are brought upon certain products. On other words, Smith & Wesson doesn't rely on any one product alone for its revenue growth, which is good for the company.

The company's revenues for the quarter Would have been higher if it wouldn't have been for the 2-day shutdown that happened in its production facilities during Hurricane Sandy. Because the demand for Smith & Wesson products is far greater than the supply, the company's revenues were constrained by how many guns it could produce in the quarter. Of course, this is a good problem to have in a relatively slow economy rather than facing a demand issue.

Due to price adjustments, cost cutting measures and increased volumes, the company was able to increase its gross margin from 30.6% to 36.8%, which represents an all-time high for Smith & Wesson. Due to the strong demand for its products, the company was able to get away with offering fewer discounts, which helped its margins greatly.

The company was able to grow its revenues much faster than its operating expenses increased, which reflects great execution from the management. In the first 3 quarters of the year, Smith & Wesson was able to grow its revenues by 45%, whereas the company's operating expenses only grew by 3% during the same period. This is simply amazing, and the company expects to keep its margins as high as they are right now for the foreseeable future.

The company's cash flow for the quarter was nearly flat, because it spent $20 million on buying back shares in December. Smith & Wesson's commitment to return cash to its investors is another reason this company is a great buy.

Smith & Wesson has about $62 million of cash in its balance sheet with nearly $50 million in long term debt. The company enjoys a current P/E ratio of 11 and future P/E ratio of 9. For a company that grows at a single digit percentage rate, the P/E ratio is extraordinarily low. As a rule of thumb, a P/E ratio of 10 reflects no growth, a P/E ratio below 10 reflects earnings decline and a P/E ratio above 10 reflects earnings growth. For example, if a company trades for a P/E of 20, investors expect the company to double its earnings in a couple years. Given Smith & Wesson's growth prospects and high margins, the company should be trading for a P/E ratio of 13-14, which reflects a possible capital appreciation of 40-50% in the next year.

I bought Smith & Wesson in December after the share price fell below $8. Back then, I sold covered calls with a strike price of $9.00 which are set to expire on March 16. Even though the share price was crashed, the options market was very bullish for the company, and I was able to obtain $90 per contract, reflecting more than 10% of gain for me even if the stock price would have stayed flat. Of course, the stock price reached $10 as of last week, and I missed out on some profits, but that's fine with me. Including my covered call sale and price appreciation, I made about 28% in 3 months. It looks like my shares will be called in a couple weeks, but I plan on buying them again and keeping them for a longer term this time. Smith & Wesson is truly a great investment right now.

As Dow Jones Index is at its all-time high, it is very difficult to find good valuations. There is no doubt that SWHC is one of those hard-to-find valuations at the moment.

You might wonder why the company saw a price decline after announcing such good results. I honestly didn't see anything bad in the company's earnings call. This may be a temporary trend tied to profit taking. For the time being, I am not worried about this company.

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.