In my opinion, Smith & Wesson Holding Corp. (SWHC) is a good investment opportunity because of its cheap valuation, compelling growth outlook, and a stable business model.
Smith & Wesson is one of the world's leading manufacturers of firearms. The Company manufactures a wide range of handguns (revolvers and pistols), long guns (modern sporting, bolt action and single short rifles), firearm-related products and accessories, as well as handcuffs. The Company's customer base includes gun enthusiasts, collectors, hunters, competitive shooters, sportsmen, individuals who are interested in self-protection, as well as security and military agencies in the United States and globally.
Handguns, long guns, walther and other products/services comprise 55.3%, 30.5%, 7.1% and 7.2% of SWHC's 2013 net revenue, respectively (for the fiscal year ended April 30). Total net revenues in 2013 amounted to $587.5 million. Compared to the previous fiscal year, the company experienced growth of 42.6% in net sales, with the majority of this growth coming from soaring demand for long guns and handguns. Gross margin accounted for 37.2% and 31.1% of net sales in 2013 and 2012, respectively. The increase in gross margin came primarily from the significant increase in sales volume, as well as from the high demand for high-margin polymer pistol products and long guns. Annual sales and EPS growth over the past 5 years stood at 14.7% and 40.9%, respectively. ROE for the year ended April 30 stood at 43.4%, according to the Dupont analysis (which states that return on equity is equal to profit margin multiplied by asset turnover and the ratio of Assets/Equity):
The company is also well-positioned in terms of liquidity and solvency, recording a current ratio of 2 and a Debt/Equity ratio of 0.24.
SWHC has a market cap of $711 million and its stock price appreciated 15.7% since July 2012. Year-to-date, the stock has returned 31.2% and it is currently close to its 52-week high of $11.40. The stock is currently trading at 9.1 times its earnings and has a forward PE of 8.0. PEG ratio stands at only 0.3 and apart from ROE, ROA and ROI are also consistently at double-digit levels, amounting to 26.6% and 38.3% respectively. The 12-month buy/sell mix (percentage mix between buy and sell recommendations excluding holds in the past 12 months) is 100%/0% for SWHC. Institutional ownership represents 55.2% of the company's equity capital.
In terms of liquidity position, as of January 31, 2013, SWHC carries $68M and $126.9M in current and total liabilities respectively and has $62M in cash. Net cash from operating activities amounted to $46.8M and $7.8M in 2013 and 2012 respectively.
Industry and regulation
The firearms industry is significantly dependent on regulatory developments. Gun ownership is embedded in the culture of the United States and although most progressive and liberal voters in the US are in favor of gun control, the current gun ownership regime is difficult to change significantly, since an amendment of the constitution is required. The industry is significantly concentrated and is dominated by a small number of companies including Browning Arms, Glock and Ruger. The supply/demand structure is favorable for the Company, given that demand has outpaced supply this year and the former is expected to be high over the coming years.
SWHC is one of the most recognizable arms brands in the world with a rich history. Apart from the consistency at selling high-quality guns, the company boasts a diverse and stable customer base, given that SWHC's products are used by many police agencies and military forces around the world. As for the services offered by the company, SWHC provides through its Academy firearms training facility services for law enforcement, military and security professionals. The Smith & Wesson Academy has trained law enforcement personnel from 50 states and more than 50 foreign countries. Moreover, the company is renowned for its innovation, given that it is dedicated to research and development and has acted as a driver for product development for more than 150 years. It also continuously increases its efforts to improve manufacturing productivity with the purpose of increasing production and efficiency.
Why Invest in SWHC
SWHC is a good investment opportunity because of the strong growth prospect and increasing year-over-year profitability. The demand for firearms in the United States is the highest it has been in the past four years and Washington is reluctant to introduce programs that will reduce demand. In comparison to competitors such as Sturm, Ruger & Company (RGR), SWHC trades at a favorable P/E ratio (9.1 vs. 12.2), which underlines the opportunity to invest. Both SWHC and RGR are showing strong signs of growth: in the last fiscal quarter, SWHC revenue grew 37.6% year-over-year, which compares closely to RGR's 38.8%. However, SWHC has been a better operated company, as its operating margin in the last fiscal quarter of 25.6% compares favorably to RGR's 23.9%. Also, its cash from operations in the last fiscal quarter was $51.3M vs. $30.4M for RGR. Smith & Wesson has also been more aggressive with regard to portfolio pruning - the Company divested its security division in October 2011, creating a one-time loss on discontinued operations, but pivoting towards higher margin business segments.
Also, Ruger has been a highly concentrated company from the revenue standpoint: some 67% of Sturm, Ruger's sales comprise pistols and revolvers, while only 2% come from non-firearm sources. In contrast, handguns make up 55% of Smith & Wesson's sales, with 7% of sales coming from parts, accessories and non-firearm sales such as handcuffs and security.
Smith & Wesson's noteworthy upside potential -- including a lower P/E ratio, and superior operating margin -- should warrant any value investor's attention. The Company's excellent cash position shows discipline with money management. Also, Smith & Wesson is more diversified than its competitors, which indicates lower exposure to market changes. While this is one catalyst I hope decreases, an uptick in burglary or other crimes would likely fuel further rises in handgun sales. Smith & Wesson definitely deserves a place on your watch list.