Smith & Wesson - Wait Before You Pull The Trigger

Jun.22.14 | About: Smith & (SWHC)

Summary

Shares of Smith & Wesson fell nearly 10% following a disappointing 2015 outlook.

Shares have seen huge momentum past year on the back of strong operations and shareholder payouts.

No real appeal yet; wait for a further correction before pulling the trigger.

Smith & Wesson (NASDAQ:SWHC) reported solid earnings for the final quarter of 2014, yet its shares saw a big correction on Friday. The reason is a disappointing full-year outlook for 2015, a year in which revenues are anticipated to fall.

Despite the correction, the shares are no obvious buy, as I am waiting for a continued or larger correction before pulling the trigger.

Fourth Quarter Headlines

Smith & Wesson reported $170.4 million in fourth quarter revenues, down 4.6% as reported compared to a year before. Excluding the Walther products sold in an agreement which ended last year, sales were down by 1.5%.

Reported earnings from continuing operations fell from $28.6 million last year to $24.9 million this year.

Sizable share repurchases resulted in earnings per share to come in unchanged at $0.44 per share. This was five cents higher than consensus estimates.

Looking Into The Numbers

The year-on-year revenue trends are disturbing, as strong handgun sales were offset by lower long gun sales. Note that reported full year results were up by 6.7% and even up by 13.8%, excluding the Walther agreement.

The company managed to boost gross margins in the final quarter by 260 basis points to 40.9% of sales. Manufacturing efficiencies, a more favorable mix and absence of lower margin Walther products were the drivers behind the increase.

These gains were offset by higher operating expenses, which rose by 350 basis points to 15.6% of sales driven by higher sales and marketing efforts, as well as the implementation costs associated to the new ERP system.

As such, operating earnings fell by 90 basis points to 25.3% of sales. Of course these remain very healthy operating margins.

Looking At 2015

First quarter sales for the new fiscal year are anticipated to come in between $130 and $135 million. GAAP earnings are seen at $0.23 to $0.25 per share. The company anticipates that one week of the annual two-week shutdown will occur during this quarter. This will have an estimated $6-$8 million revenue impact.

Annual sales are seen between $585 million and $600 million, on which the company aims to earn between $1.30 and $1.40 per share. At the midpoint of this guidance, Smith is assuming a roughly 5% decline in annual revenues, while earnings are seen down by about 10%.

Analysts were expecting 2015's revenues to come in as high as $622 million. Consensus estimates for first quarter revenues were actually much higher than Smith's guidance at $161 million.

Valuing Smith & Wesson

The company ended the quarter with $68.9 million in cash and equivalents. To finance last year's share repurchases, the company has incurred a $100 million in notes payable, which results in a roughly $31 million net debt position. In comparison, last year the company held a comfortable net cash position which it used to retire 14% of its share base over the past year.

At $15.50 per share, equity in the business is valued at roughly $850 million. This values the company at 1.4 times annual revenues and 11-12 times anticipated earnings going forwards.

Smith & Wesson does not pay a dividend at the moment.

Some Background Perspective

The decline in fourth quarter revenues and guidance for lower full year revenues in 2015 might be disappointing, but note that 2014 has been a record year for Smith & Wesson.

Robust consumer demand was the driver of 2014's results as the company continues to focus on the core firearm business while expanding manufacturing capacity in a modest step-by-step way. The company has focused on vertical integration of the supply chain as well, after acquiring a molding supplier earlier this year. This increases the flexibility while reducing supply chain risks.

The company is confident that it can continue to gain market share as the market for firearms is returning to more normal levels. This is after the past year has been very strong on fears that tighter gun controls would follow mass shootings in December of 2012.

The strong 2014 has been a major driver for returns, with shares having returned nearly 60% over the past year despite Friday's sell-off. The company's massive share repurchase program in an already very favorable operating environment is partially to thank for that. Since December of 2012, the company has repurchased 19% of its shares outstanding, with currently still $27 million in repurchases being authorized.

My Takeaway

I don't necessarily believe that the pullback on Friday results in an obvious buying opportunity after the huge momentum last year and the disappointing guidance for 2015.

Shares now trade around 11-12 times forward earnings, which seems attractive. Yet note that growth is negative and that earnings multiples for firearms producers are quite low, given the continued uncertainties about long-term regulation and demand for guns.

Given these reasons, I need a bigger margin of safety before picking up some shares, with shares still trading with year-to-date gains of about 15%. Around $14 per share, I might be more tempted to pull the trigger.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.