Are You Feeling Lucky, Punk? Then Sell Naked Puts On Smith & Wesson
Summary
- Gun ownership is a constant in the US. There is always a market.
- While that market may fluctuate in demand, legendary names like Smith & Wesson will always fall into value territory at some point.
- Smith & Wesson is cheap right now.
- That creates opportunity to pick up shares on the cheap and collect income selling naked puts.
Thesis
Can there be too many guns in America? Not according to gun owners. Setting aside the politics surrounding guns, the simple fact remains that there are more guns than people in the country.
The 2018 Small Arms Survey reported that there are 393 million guns in America. Oh yeah, guns are so popular that they also exceed the number of registered vehicles... by over 100 million! Just how many people own guns? Roughly 30%, according to Pew Research. Two-thirds own a gun for protection, and that point has been driven home by owners, who point to the recent riots as justification. Even as generations grow old and pass on and are replaced by new ones, gun ownership appears to be something passed down, because for the previous half-century, ownership only fluctuated between 37% and 45%.
That helps explain the NRA’s tally of near 6.6 million guns manufactured or imported every year. Riots and the pandemic have only stoked ownership, with all the major manufacturers reporting increased sales. Lake Street Capital Markets* said the following about manufacturer Sturm, Ruger & Company (RGR) on June 2:
“May demand for firearms exceeded our expectations significantly. Historically speaking, this level of demand is unprecedented and has continued longer than we expected. With the outbreak of civil unrest very late in May, we think the high demand is likely to continue into June. Although it is hard to weigh the drivers in demand, we think there is still some unfilled demand from COVID, recent buying due to civil unrest and continued and perhaps heightened buying due to the upcoming election and potential for increased regulation following the election."*
FBI firearm background checks have also grown significantly over the past twenty years. In other words, firearms manufacturing and sales is a good business. Not only is there a floor to gun ownership, but the overall long-term trend shows growth despite periods of choppiness.
This all translates to good times for the famous Smith & Wesson Brands, Inc. (NASDAQ:SWBI).
SWBI has never been a sexy stock. Yet, its history of cash flow has been slow and steady.
Valuation
SWBI is a bit of an oddball when it comes to valuation. It has a degree of cyclicality that is actually based more on psychology than the economy itself, or even basic supply and demand.
As such, we look to operating cash flow as the metric. SWBI belongs to a handful of consumer discretionary stocks that don’t experience regular growth. This includes many of Liberty Media Corporation’s (OTC:LMCB) assets, as well as what used to be separate stocks for Home Shopping Network and QVC, among a few others.
Historically, the average P/OCF over the past ten years has been about 9. Right now, it sits at about 8.3, making it a comparative value.
Risks
SWBI has its own set of unique risks because of its industry.
There exists one form of risk that will never go away, and that is the never-ending fight against gun control. The NRA is one of the most powerful lobbying organizations in the country. They rarely lose legislative or regulatory battles. Nevertheless, there is always a risk that federal or state legislation may significantly restrict the sale of firearms.
Related to this matter are various court cases working their way through state and federal courts. The Supreme Court has generally been loath to place undue restrictions on gun ownership. However, that could always change.
Liability is also a risk that will never dissipate. At some point, some day, a gun manufacturer will be sued for liability in a mass shooting. It will be costly. SWBI is not a cash-rich company, and it could be put out of business if it loses a big case.
There is risk that the banking and financial industry may choose to, or be forced to, stop dealing with the gun industry. Operation Choke Point, during the Obama Administration, tried to choke off access to banking services for the gun industry.
Demand is choppy. It declines when gun control talk is quiet. Right now, everyone is stocking up, but we saw demand fall once Trump was elected.
Competition is another ongoing threat. Gun owners tend to find a brand they like and stick with it. If SWBI isn’t making guns that resonate with owners, it could lose market share.
Supply chain disruptions, both as a result of COVID-19 and from lack of raw material availability, could also harm company sales.
Actionable Conclusion
SWBI closed at $16.60 on Wednesday. The July $15 puts are going for about $1.10 each. Earning more than 7% in just 6 weeks is an incredibly generous premium, especially considering the premiums are usually about 3%. If SWBI shares are put to you, you will be buying at the equivalent of $13.90 per share, which is about a 16% discount from even this value price.
For those who want to wait a little bit longer to see how the recent unrest shakes out, the October $12.50 puts are going for about $2. If put to you, you will be buying SWBI stock at the equivalent of $10.50 per share, a discount of more than 30% from this already cheap price point.
Finally, for the most conservative choice, allowing you to wait until the election is over, the December $13 puts sell for about $1.60 each. You first earn 13% on your money, and in the process, you'd be hedging your SWBI stock bet all the way down to $11.40 per share.
*Edited, June 11: A previous version of this article accidentally attributed this quote to Sturm, Ruger. The quote came from Lake Street Capital Markets. We regret the error.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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