Shares of Smith & Wesson (SWHC) took a beating after the Street is overreacted to a weak second quarter outlook which was entirely driven by planned production outages, and costs and lost revenues related to the implementation of a new ERP system.
Given the strong full year outlook, the modest and very appealing valuation, it is time for investors to re-load.
First Quarter Results
Smith & Wesson generated first quarter revenues of $171.0 million, up 25.8% on the year before. The company notes that it continues to operate at maximum capacity, as it beat on consensus estimates of $165.0 million.
Income from continuing operations grew by 40.2% to $26.5 million. Diluted earnings per share rose from $0.26 last year to $0.40 per share. This even included a $0.05 per share one-time expense related to the retirement of 9.5% senior notes and the issuance of new notes.
The adjusted earnings per share of $0.45 comfortably beat consensus estimates of $0.36 per share.
CEO James Debney commented on the past quarter's developments, "Our results for the first quarter of fiscal 2014 reflect the continued successful execution of our growth strategy. We delivered improvements across all of our key metrics, including a meaningful increase in year-over-year sales and significant expansion of our gross margins. Ongoing increases in our manufacturing capacity, combined with strong consumer demand for firearms, resulted in increased market share and higher sales of our most popular M&P® products."
Looking Into The results
While the reported 25.8% revenue growth rate looks impressive, this actually understates the real strength in demand for its products. Excluding the sales of Walther's products from last year's distribution agreement, sales were up by 36.4%.
Gross margins rose by 490 basis points to 42.6% of total sales. Margins were up on higher volumes, the leverage of fixed costs and a more favorable product mix.
At the same time, operating expenses fell by a modest 20 basis points to 14.5% of total sales on the positive leverage, resulting in operating income which rose by 510 basis points to 28.1% of total sales.
Looking into the second quarter, the biggest news is the increase in operating costs guided for the quarter.
While demand remains strong, production days will be very low. On top of a normal two week factory shutdown every summer, the SAP completion will stop production for another 8 days during the quarter. As such production days will come in at just 50 compared to 63 in the first quarter.
All in all, revenues are seen between $135 and $140 million for the quarter, down 20% compared to the first quarter. All this will have an impact on gross margins. The ERP implementation, incentive based compensation and an increase in general spending will at the same time result in a 20% increase in operating spending compared to the first quarter.
All in all, earnings are seen between $0.20 and $0.22 per share. This is below consensus estimates of $0.29 per share. Analysts were looking for revenues of $143 million.
Full year earnings are seen between $610 and $620 million, while earnings should come in between $1.30 and $1.35 per share.
Smith & Wesson ended the quarter with $146.5 million in cash and equivalents and a $100 million of outstanding senior notes, with no borrowings under the revolving credit facility.
During the quarter the company issued $100 million 5.875% senior notes due in 2018, and used a portion of the proceeds to repurchase $49.2 million of 9.5% senior notes outstanding.
Smith & Wesson generated annual revenues of $587.5 million over the fiscal year ending in April of this year, which was up 42% on the year before. Net earnings totaled $78.7 million for the year.
Factoring in losses of around 10%, with shares exchanging hands at $10.30 per share, the market values the company around $650 million, or its operating assets at $600 million.
This values operations of the company at 1.0 times annual revenues and 7-8 times last year's earnings.
Despite the solid profitability and the strong cash position, the company does not pay a dividend at the moment.
Some Historical Perspective
Long term holders of the company have seen their fair share of volatility. Shares rose from levels just above $1 in 2004 to highs in their low twenties during the summer of 2007. Shares ended that year around $5 but since the start of 2012 have gradually gained ground on strong gun sales. A recent peak around $13 in August was the highest level since 2007.
Between the fiscal year of 2010 and 2013, Smith & Wesson has grown its annual revenues by a cumulative 64% to $587.5 million. Net income rose by over 140% to $78.7 million in the meantime.
The market is not pleased with the combination of a revenue fall in the second quarter, accompanied with an increase in costs. These are temporary glitches, but they still hurt and are larger than anticipated.
Fundamentally, nothing has really changed as the M&P polymer pistols perform well, allowing the firm to gain market share in a growing market. At the same time, progress has been made on building the manufacturing capacity and infrastructure to handle future demand. This includes the new ERP system from SAP. The company notes that is has been running at full capacity for 6 quarter already.
While the second quarter outlook is weak, the full year outlook is solid, more than offsetting short term weakness. The long term growth trend remains intact, and the current valuation in combination with strong guided earnings for the remainder of the year should bode well for shareholders. The full year guidance was roughly in line, or slightly beat consensus estimates for earnings of $1.30 per share on revenues of $612 million.
Besides adding capacity and developing new initiatives, the company is using excess cash to please shareholders with the current $100 million share repurchase program. On top of that comes the strong market fundamentals coupled with market share gains.
All in all, investors should re-load and could pick up some shares as the sell-off based on the current quarter guidance is a severe overreaction given that long term fundamentals remain intact.