American Outdoor Brands Is A Buy

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Includes: AOBC
by: Philomena Doyle

Summary

Investors have overreacted to the latest earnings announcement from American Outdoor Brands.

This overreaction presents a huge buying opportunity at these prices.

Management has a history of understating the future, and that is the reason why shares have dropped. We should take advantage of the market's inability to spot this disconnect.

As I learn more and more about the behavior of stock markets, I begin to understand that, in the short term at least, they make no sense. There are many examples of this phenomenon that I've come upon recently, but the one that sticks out for me is what has happened to the share price of American Outdoor Brands (NASDAQ:AOBC) in light of the company's recent earnings announcement. The shares are down around 11% from their pre-announcement price, and that makes no sense to me. In my opinion, investors should take advantage of the disconnect between the share price and the fundamental value here. The real value here is the fact that the market seems unaware of the fact that management is perennially pessimistic in its forecasts. I believe that investors have reacted to the forecasts without reviewing how excessively pessimistic prior forecasts have been.

Why I Like The Company

I like the company primarily because it generates a nice double-digit return on assets (in the order of 17.75% at the moment) and a very decent return on equity of around 34%. Also, this is certainly not a new trend with American Outdoor Brands. The company has been earning an extraordinary amount of income for a very long time. For instance, as demonstrated by this chart, both revenue and net income have been growing nicely since.

(Source: GuruFocus)

In addition, both the return on equity and return on assets that the firm is capable of generating have been traditionally quite high, as demonstrated here:

(Source: GuruFocus)

The thing I find strange about American Outdoor Brands is that management seems to be perennially understating what the future will hold for this business. For example, in 2016, it predicted fiscal 2017's sales would be approximately $760 million. Sales were 19% greater than that figure. This is a recurring trend associated with management here, as demonstrated by the table below. The "actual" column is what happened, and the “prediction" column was management's forecast in the prior year.

Actual Prediction % Difference
Fiscal 2017
Sales 903.2 760 19%
GAAP EPS 2.25 1.81 24%
Non-GAAP EPS 2.58 1.93 34%
Fiscal 2016
Sales 722.9 615 18%
GAAP EPS 1.68 .9 87%
Non-GAAP EPS 1.83 1.07 71%

Given that, it's very difficult to take management seriously when it suggests that the next year's sales will only be around $790 million. Management has been so excessively conservative for so long that its forecasts should be taken with a very large grain of salt.

In addition, I think investors can be somewhat myopic in their thinking, and there are fewer better examples that I've found than American Outdoor Brands. In particular, investors might focus on drawing conclusions based on the comparison of NICS data in the first half of 2017 relative to 2016. A cursory review of this chart would suggest that firearms manufacturers face some headwinds in future, given that background checks are down about 8% from the year-ago period.

(Source: fbi.gov)

It's certainly true that 2017 has been more sluggish than 2016, but that "insight" hides a wider truth, namely, that firearms applications are up quite dramatically over a five-year span. 2016 was an extraordinarily "hot" year, and thus, any period juxtaposed against that one may appear unnecessarily anemic. It could just as easily be said that the 2017 numbers we have are now about 20.4% greater than they were in 2015. In my view, it would therefore be wise for investors to take a longer-term view of the positive trends in place and not anchor on a simplistic comparison to whatever happens to be the most recent period.

Why I Like The Stock

I read recently that investing is an inherently relativistic game, meaning that if we buy "x," we must by definition want to either avoid or sell "y." Over the long sweep of history, investors have been most often consistently rewarded by buying assets that the crowd is avoiding. It certainly doesn't guarantee success (the crowd may be avoiding an investment for good reason), but if you can find a great, sustainable business at a good price, then your chances of success go up dramatically. In my view, AOBC is such a business. The stock is trading at a significant discount (60% on a P/E basis) to a market that could be described as "frothy." In addition, the fact that the shares are down about 20% over the past twelve months presents an enormous gift to prospective shareholders. There's obviously a risk that the shares will continue to languish, but over time, in my opinion, the obvious value here will become apparent and shares will rise.

In my view, the crowd is avoiding shares of AOBC for two specific reasons. First, they are taking management's conservative estimates at face value and not digging in to realize that management consistently understates the future. Second, the stock may be suffering from a challenging comparison, given that 2016 was an extraordinarily good year. Taking a longer-term perspective here shows that the appetite for firearms in the United States is alive and well.

In conclusion, I should point out that the lower the price you pay for a given assets, the greater your future returns will be. Given that these shares are down dramatically, while the business itself continues to grow represents an excellent opportunity for prospective shareholders. I think investors should look past the short-term noise generated by management's excessive pessimism and any short-term comparisons and buy and hold this well-run, high-ROA business.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AOBC over the next 72 hours.

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.