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Summary

  • Smith & Wesson maintains its formidable presence in the defense products industry drawing on its 150+ year history to consistently deliver valuable products to a growing market.
  • Priced just under $17 a share with a P/E ratio of 11.0 versus 21.1 for its industry and a P/S ratio of 1.5 versus 2.4, S&W offers a compelling valuation.
  • The firm has experienced revenue growth of 72% since 2011.
  • Net buying from insiders.

Introduction

Smith & Wesson Holding Corp. (NASDAQ:SWHC) is one of the most prominent manufacturers of firearms and firearm accessories for individuals, law enforcement, and military customers. Although the hotly contested debate over gun control in America may turn investors away from this stock, from a business standpoint we think it deserves consideration.

Outlook

While this industry is highly regulated, Smith & Wesson has managed to more than triple their earnings in 2013 year over year.

Total domestic retail sales in the third quarter of their current fiscal year grew about 20% YOY, and sales into the professional channel declined about 6% YOY. Total sales have increased by 72% since 2011. S&W implemented several targeted price increases in the month of January. In our view, this is a noteworthy action given that the industry is no longer operating in the post surge environment of 2011, and serves as a testament to the strength of both the brand and product portfolio.

During the previous fiscal year, 7.6% of sales came from state and local law enforcement agencies and the federal government, 3.3% of sales from international customers, and the remaining 89.1% of sales were made through the highly regulated distribution channel to domestic consumers.

Source: Zacks Research System (ZRS) Copyright 2007-2013 Zacks Investment Research, Inc.

Looking forward for S&W, we anticipate sales growth will return to normal, more sustainable levels. However, the threat of renewed legislation may provide additional upside return. S&W's ten year annualized growth rate has been 17%. Even in a lower growth scenario, valuations remain attractive. Zack's earnings per share model, assuming a conservative growth rate of 5%, projects a one-year return of 17-20%. There is also the potential for additional upside if there are new attempts to pass restrictions on firearms. Putting politics aside on this issue, historically, in times of higher public interest in gun control legislation, sales and profits in the industry have dramatically risen. Shareholders gained 60% on their holdings of SWHC following the attempts to introduce additional legislation in 2011.

President and CEO James Debney recently announced the conversion of the company's Houlton, Maine manufacturing facility in to a state-of-the-art precision machining center, moving the assembly operations into the Springfield, Massachusetts facility. The consolidation of these key internal operations has enhanced efficiency while reducing risk, thus supporting higher margins and the future growth of the company.

Also note that major capital expenditures for fiscal 2013 relate to increasing capacity for existing products, tooling for new product offerings, implementation of a new Enterprise Resource Planning (ERP) system, and various projects designed to upgrade manufacturing technology. These improvements will enable S&W to maintain strong margins and consistent earnings growth. In this environment of low CAPEX, S&W represents a rare bright spot, positioning them for strong and sustainable future growth.

Decreasing debt levels also reduce the company's risks and signal a healthy level of cash flow capable of financing continued growth.

Source: Zacks Research System (ZRS) Copyright 2007-2013 Zacks Investment Research, Inc.

In our view, management's decisions related to fixed capital spending, leasing of equipment and increasing levels of cash on hand have positioned the company to weather any future legislative or governmental actions negatively effecting operations. Furthermore, increasing levels of free cash flow allow S&W to continue funding growth expenditures, future acquisitions, and share re-purchases.

During the third quarter of 2013 the company bought back 1.1 million shares of common stock for $15 million, completing the latest stock buyback authorization. Since December 2012, they have repurchased 12.2 million shares of common stock at an average share price of approximately $11, for a total stock buyback of $135 million, and a reduction in float of nearly 19%. At the current share price of $16.6, this has resulted in a buy back ROI of 51%. (Source: SWHC Earnings Conference Call, 03/04/14)

Source: Zacks Research System (ZRS) Copyright 2007-2013 Zacks Investment Research, Inc.

Risks:

  • 3-year Beta of 1.92 (Yahoo Finance); Historical Best of 1:09 versus historical Russell 2000 Beta of 1:30 (Zacks Research Wizard).
  • The Firearms industry is highly cyclical.
  • Technology trends, including biometrics and micro-stamping, could negatively impact margins as a result of increased manufacturing and regulatory costs.
  • Changes to both federal and state legislation surrounding gun control could have a significant and material impact on sales and the company's operations.
  • Continued shortages of ammunition may negatively impact interest in and sales of their products.

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Source: Smith & Wesson Grows Amidst Regulations