Should You Buy The Drop In Vista Outdoor?

About: Vista Outdoor (VSTO), Includes: OA
by: Ranjit Thomas, CFA

VSTO is down big on a write-down announcement.

The company has a decent business, but is not hugely undervalued.

An actionable options trade is recommended.

Vista Outdoor (NYSE:VSTO) is down more than 20% today as the company announced that it will take a goodwill write-down of $400-450 million due to deteriorating trends in its business. Usually, a goodwill write-down as a non-cash charge is not a big deal, although it is an indicator that the company overpaid for an acquisition in the past. It's funny how companies always emphasize that a write-down is non-cash in nature, ignoring the fact that it required a huge cash outlay in the past.

For those unfamiliar with the company, VSTO is a manufacturer of accessories and ammunition for the hunting market. Apparently, the election of Donald Trump is resulting in people finding it less necessary to stock up on ammo.

VSTO was spun out from Alliant Techsystems, which used to trade under the symbol ATK, and is now known as Orbital ATK (NYSE:OA). The company had much promise, but has repeatedly shot itself in the foot trying to wheel and deal with ill-conceived mergers, acquisitions, and spin-offs. VSTO apparently has inherited some of this in its DNA. The company has spent more than $450 million on acquisitions in each of the last two years, with nothing much to show for it. Hopefully, the current stock drop will nudge management in the direction of focusing on running the business rather than chasing deals.

A review of the company's financials reveals a decent business, with revenues of $2.7 billion expected this year at a low double-digit operating margin. Although the company has taken on debt to fund acquisitions, at a little over $1 billion, it is pretty manageable in relation to the company's profits and $1.8 billion market cap. The company has also been buying back stock as it has declined, which in retrospect has not been a wise move, with the stock now much lower. Free cash flow has largely been in line with net income, indicating that the quality of the earnings is good.

The company is projected to earn $2.68 per share this year on a pro-forma basis, excluding a settlement gain and some minor transaction costs, rising to $3 per share next year. These estimates are in question, but the company should be able to do between $2 and $2.50 per share this year and next. At a 14x multiple, the stock is worth $30-35, which is not too much upside from the current level of a little below $30. However, with the drop in the stock, implied volatility is elevated and I would recommend selling the $25 strike puts. The May expiration would net you $1 at the mid-point of the current bid-ask spread. This amounts to a 4% return on the notional value, or a 12% annualized return with low risk, since you are protected up to a further 15% decline in the stock. Finally, as a largely domestic manufacturer with a tax rate above 30%, the company should benefit from the tax policies the new administration intends to enact.

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Disclosure: I am/we are short VSTO PUTS. 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.