American Outdoor Brands (AOBC) came flying out of the woodwork in its latest quarterly report, posting a huge earnings beat and issuing strong guidance. With an apparent return to stronger profit margins and an end to the strong promotional environment, AOBC is back on my watch list. However, the high forward P/E multiple, shaky visibility on free cash flow, and ongoing uncertainties regarding its post-distribution center's future are keeping me on the sidelines for now.
Strong Business Performance
The most positive sign in the quarterly report was the healthy demand for the company's firearms products at normalized prices. Products launched within the past year represented nearly 30% of total firearms revenue, showing that R&D dollars are being well allocated by management (which remains a significant dollar priority on its budget moving forward) and the sustained strength of AOBC's firearms brands. This strength was especially apparent in the long guns business, as there was a wide gap between the 11.5% year-over-year decline in NICS during the quarter as opposed to AOBC's 37.8% quarterly year-over-year growth in units shipped to distributors and retailers. For the same period, background checks for hand guns declined 12.6% year over year, while units shipped to distributors and retailers declined 21.9%. In the larger hand gun business, year-over-year comps were relatively flat, accounting for last year's aggressive M&P Shield promotion which drove sales abnormally high during last year's quarter. The good news here was that the relatively flat adjusted comps in hand guns and solid 5% overall firearms top-line growth were achieved at significantly higher profit margins from last year (630 basis points year-over-year overall company improvement) due to reduced promotional costs and more efficient production processes (reducing costs by 10% year over year) which have adjusted to the decreased demand levels from prior to the 2016 election. This seems to imply that AOBC's firearms business has not only stabilized, but has returned to a healthy growth trajectory, despite significant ongoing declines in NICS figures.
Another highlight from the company's quarterly business performance was the strong organic growth in the Outdoors products business (10.7% year over year and 14.5% including acquisitions), which drove 25% of the company's total revenue and accounted for a significant portion of its 7.6% year-over-year overall top-line growth. These figures bear testimony to the success of management's acquisition strategy: targeting strong brand names with organic growth prospects that can be further enhanced when combined with AOBC's strong innovation capabilities and bundling with its broader array of firearms and outdoors products. The forward outlook in the business looks encouraging as well, with expectation-beating orders for new product releases set for delivery in Q2.
Continued Debt Reduction
The second major takeaway from the quarter was that the company's balance sheet continues to look better and better. Free cash flow was solidly in the green during the quarter, despite a history of negative free cash flow during the first quarter. However, free cash flow (and earnings) will likely take a substantial hit moving forward due to increased capital spending and depreciation on the distribution center. However, management believes that improved efficiencies and synergies from this investment will yield double-digit annual returns on invested capital over the long term.
Even better, net debt has declined by ~32% over the past twelve months and management fully paid off AOBC's line of credit debt during Q1. When combined with its $25.2 million cash on hand, AOBC's $500 million line of credit capacity gives the company significant liquidity to fund any and all investments necessary to effectively get its distribution center up and running and then begin to look at opportunistic acquisitions and/or share buybacks, all of which should drive strong shareholder returns over the long run. To give perspective on how huge its liquidity is, even after Friday's enormous 44% share price increase, the company has the liquidity to potentially buy back 2/3 of the company's total market cap right now.
Encouraging, But Unclear Outlook
As management stated during the earnings call:
the consumer market for firearms remain somewhat uncertain...
However, management did raise guidance following Q1, based on the success of synergized sales efforts between the firearms business and the outdoors business as well as the strong popularity of its new products such as the Shield 380 EZ. With a mid-point non-GAAP EPS of $0.64, for FY19, that makes its current share price of ~$14 trade at a forward P/E of ~21.9x and its GAAP EPS multiple nearly double that.
While the stabilization and much improved margins during Q1 alongside the booming outdoors business are certainly very positive signs, a forward P/E of over 20x with a high degree of uncertainty attached to it seems a bit rich. While management does expect earnings and free cash flow to be tempered over the short run due to investments in its distribution center completion, which in turn is expected to yield strong returns later on, the somewhat saturated state of the firearms marketplace (as evidenced by the still declining NICS numbers) makes the current uptrend in performance too early to put a lot of confidence in as the start of a new long-term growth trend.
The encouraging Q1 numbers, particularly in margins, caught my attention and put AOBC back on my watch list. The firearms business, with its improving profitability, appears to be back, boosting share prices across the industry (including Sturm, Ruger (RGR) and Vista Outdoor (VSTO)). However, after Friday's run-up, prices seem a bit rich. I think a mid-teens forward multiple is much more reasonable to pay for shares, given the still uncertain outlook and the company's lack of intent to deploy free cash flow into acquisitions and/or buybacks for the near future. I am waiting for prices to decline into the $10-12 range before considering making a purchase.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.