Smith & Wesson Holding Corporation (SWHC) engages in the manufacture and sale of firearm products in the United States and internationally. On Wednesday, July 10th, the company announced that it was increasing the price of its tender offer from $10/share to $11/share to purchase up to $75 million in company stock. The original offer was made on June 13th when the shares were trading at $9.30. The $11/share offer represents a premium of 18.3% from the June 13th closing price. The company decided to increase the offering price because only 64,680 shares were tendered representing $646,800 of the $75,000,000 the company was looking to purchase. Unless you are a short-term trader looking for quick profits, I would suggest rejecting the revised tender offer from Smith & Wesson.
Sales, Earnings and P/E Evaluation
Even though Smith & Wesson increased their tender offer by 10%, the shares of the company are still grossly undervalued. Smith & Wesson just reported their 4th quarter fiscal 2013 results last month and the company generated a record $588 million in sales for the year and a diluted EPS of $1.22. At the tender offer price of $11/share this represents a P/E of only 9. Generally speaking, low P/E ratios are usually reserved for mature companies or ones that investors think earnings are likely to decline in the future. Smith & Wesson issued guidance for fiscal 2014 and they expect sales of $605 million to $615 million and EPS from operations of $1.30 to $1.35 per share. Based on the forward guidance, this company does not look like it's in a declining mode. While to the naked eye it might look like growth is slowing, it should be noted that the company's distribution agreement with Walther ended in fiscal 2013. If you exclude Walther revenue from the 2013 fiscal year sales the company is growing sales at 12% year-over-year at the mid-point. It should also be noted that management has beat or met expectations each quarter in the last fiscal year.
If you evaluate the tender offer of $11/share against the low point guidance of $1.30 EPS the forward P/E is 8.5. The P/E of Smith & Wesson has been steadily declining even though sales and earnings have been increasing. Just one year ago the P/E ratio was nearly 40 and pre Sandy Hook had a P/E of 12. If we apply the pre Sandy Hook P/E of just over a half a year ago the price of Smith & Wesson would be $14.64.
Management is also committed to buying back shares of company stock. In addition to the $75 million tender offer for shares the company also announced a buyback of an additional $25 million on the open market. Jeffrey D. Buchanan, Smith & Wesson Holding Corporation Executive Vice President and Chief Financial Officer, stated in the last earnings conference call,
Building on the strength of our record profitability, robust cash flows, and rising cash position in fiscal 2013, we recently accelerated a number of steps to optimize our capital structure and generate increased value for our stockholders.
As management continues to reduce the float, the EPS will increase without having to grow sales.
Future Sales Drivers
If a bear were to evaluate Smith & Wesson, they would argue that the gun bubble has burst and sales have peaked due to gun control fears being eased since the gun control legislation was shot down a few months ago. I would argue that the battle for gun control is still not over and will continue to be a driver of sales in the near future.
In June, Vice President Joe Biden claimed that "at least five senators" have contacted him about changing their votes they cast to block the expanded background checks as they have seen their approval ratings drop since casting the vote. Biden also did comment about the difficult path ahead for gun control.
Another gun control issue that has flown under the radar is the United Nations Arms Treaty that could potentially ignite the gun control debate again. This treaty would attempt to control the trade of firearms between countries. As of July 10th there were 79 countries that had signed the treaty and two countries, Iceland and Guyana, which had ratified the treaty. At least 50 countries need to ratify the treaty in order for it to be entered into force. President Obama is expected to sign the treaty despite any funding for this treaty being unanimously rejected by the House in June.
The consequences of the treaty are just being speculated right now, but I would argue that it would be a further driver of Smith & Wesson sales if the issue heats up. As we saw during the first half of 2013, NICS background checks and gun sales were at an all-time high thanks to gun control measures being proposed post Sandy Hook. If the treaty is ratified by enough nations and the United States declines to participate, there could be a ban on imported guns in the U.S. which would drive up the price and demand for domestic firearms. Again, that is just speculation, but anything could happen.
Regardless of the gun control debate, another potential driver of gun sales is women. It is estimated that 15 to 20 million women own firearms in the United States. This market has a lot of growth potential and manufacturers have increasingly marketed guns to women showcasing smaller frames and even custom colors like pink. Sales of gun fashion accessories like purses designed for concealed carry are booming.
The Bottom Line
In summary, I would say reject the tender offer from Smith & Wesson if you're a long-term shareholder. Management has proven its commitment to the stock by aggressively buying back shares and its P/E ratio is cheap. Any future gun control fears will be a further driver of increased sales as well as the growing market of female shooters. I would also argue that the tepid response to the company's tender offer is a bullish sign. This means that the current shareholders were not parting ways with their shares even though the share price had not been over $10 since the beginning of March. Don't pull the trigger on Smith & Wesson shares until the mid-teens.