Smith & Wesson: Take The Long Shot

| About: Smith & (SWHC)

Summary

Smith & Wesson consistently beats earnings expectations.

NICS reports 30% permit application increase.

Expansion of existing product lines and entry into new markets.

Smith & Wesson (NASDAQ:SWHC) is set to report Q4 earnings after the close today, June 16, 2016, and there are a few reasons I believe this could present an opportunity to open a long position in the next couple of days. After a surge in share price in May, the stock has recently tumbled back down and is now resting at just 10% above its year-to-date low of around $20 per share. Much of this decline is due to some recent downgrades from analysts, yet the stock still retains an average annual price target of $28.89, presenting an upside of over 30%.

Smith & Wesson is a widely recognized brand that has the largest revolver market share in the industry. They are in the midst of a multi-year growth plan to launch off their strong brand. After purchasing gun and outdoor accessory company, Battenfeld, they have expanded their accessory offerings to make themselves a one-stop-shop for everyone from hunting enthusiasts to law enforcement. Also part of their growth plan, is creating business solutions, including HR, IT, and manufacturing, for their other business segments to create a more seamless integration, cost savings, and increased value across their entire business.

They have a solid financial position when looking at a few of their metrics. They have a relatively low forward P/E ratio of $13.17, compared to Sturm, Ruger & Co.'s (NYSE:RGR) forward P/E of $21.47. They have a cash balance of $105 million, and with a Debt-to-Equity ratio of just .70, they have a good position to weather any macroeconomic events. They also have a strong earnings history, with upside surprises in six of the last seven quarters as well as steady year-over-year growth.

In the most recent quarter, Q3 2016, Smith & Wesson beat the analyst consensus of $0.39, by over $0.20 per share and gave their full year's earnings an upward revision. Each time they have beaten earnings expectations in the last four quarters, we have seen a spike in share price of around 10%. This next quarter has an average earnings expectation of $0.58, which is a high target to achieve, but there are a number of factors that I think can help them beat this number.

To support this, we can look at Sturm, Ruger & Co., who recently reported earnings at the beginning of May. They beat earnings estimates by $0.27 in a quarter that analysts have been worrying about decreasing demand. This gives me confidence that Smith & Wesson can follow suit with a strong earnings report.

First, their 4th Quarter has historically been one of their strongest earnings reports, and with their recent revisions, I would be surprised by a weak report here. They have been further expanding their business into gun accessories that help drive additional sales to a wide range of gun buyers. In addition, they have also begun adding segments to their brand to attract new customers.

Specifically, gun sales to women have seen over 60% growth over the past 15 years. This presents a huge opportunity for a whole new market for these gun makers. The company has begun to make advances in this segment with a number of initiatives. They have released their "LadySmith." They are the first gun manufacturer to design and produce a handgun that is specifically tailored to women.

This is their first step into this growing market segment and with growing safety issues, I think we can expect further growth in this demographic. Another apparent strength is the NICS report on background checks for guns. The report for February 2016 through April 2016, shows over a 30% year-over-year growth in permit applications. While this is not directly correlated with Smith & Wesson sales, it is a strong indicator that demand for guns not only remains strong, but is still growing.

While there looks to be a lot of potential given the recent price drop, historical performance, and industry growth, there are still some concerns that could hurt the company. While the recent tragedy in Orlando, Florida has caused security concerns and a recent spike in share price, the long-term effects of these events deepen worries of increased gun-control regulations and could have a huge negative impact on the future of the company.

Making guns more difficult to acquire for consumers, would have a huge effect on the company's sales. Additionally, they face fierce competition from companies like Sturm, Ruger & Co., Glock, and Vista Outdoor (NYSE:VSTO), all of whom make quality firearm products. Sturm, Ruger & Co. has also seen earnings growth in their most recent quarters, displaying strong demand across the industry.

While there are a number of arguments and uncertainties for both longs and shorts, I believe, that given the current outlook of the industry, the positive aspects outweigh the potential downside risks. With a relatively low share price, steady earnings growth, increased demand, and financial position, I think Smith & Wesson could provide a profitable short-term long position.

Disclosure: I am/we are long SWHC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.