This Gun Maker Just Blew Away Earnings Estimates

Gun-loving investors, rejoice! On Tuesday, firearms manufacturer Smith & Wesson (NASDAQ: SWHC  ) just capped a banner year with a record fiscal fourth-quarter earnings report.

So why did the stock fall more than 3% Wednesday morning?

Some background
Well, this wasn't exactly a huge surprise, especially considering shares of Smith & Wesson rose more than 5% after the company gave investors a heads-up nearly two weeks ago with preliminary results, saying fourth-quarter net sales rose around 38% from the same year-ago period to $179 million, while GAAP net income grew 63% to $0.44 per diluted share.

At the same time, they also told us net sales for the year rose 43% year over year to $588 million and 2013 GAAP net income more than tripled from last year to $1.22 per diluted share.

Next, Smith & Wesson took the opportunity in their pre-release to announce a significant debt exchange of $49.2 million in 9.5% notes for $75 million of new, lower interest 5.875% notes, primarily to take advantage of lower interest rates and to afford them the chance to make "strategically opportunistic" investments with the difference in principal.

Finally, the company announced a $100 million stock repurchase program, whereby $75 million would be repurchased through a fixed-price issuer tender offer at $10.00 per share -- or a premium of 3% to the current share price of $9.71 per share -- with the remaining amount to be handled either in the open market or through privately negotiated deals. In all, the buyback had the potential to reduce the number of outstanding Smith & Wesson shares by as much as 15%.

The bigger picture
That was all well and good, but Tuesday's release gives us a better view of the bigger picture for Smith & Wesson -- and from what I can tell, that picture is largely a good one.

Sure enough, the pre-release numbers proved accurate, and the company reaffirmed that, while it continued to increase its production capacity, it's still "unable to meet the ongoing demand across most of its firearm product lines, resulting in additional growth in the company's order backlog."

However, yesterday's press release also indicated that the company has since sold an additional $25 million in 5.875% notes, bringing the total new debt issuance to $100 million, with no additional plans to issue more going forward. 

In addition, the $75 million fixed-price tender offer at $10 per share commenced on June 17, 2013, and is expected to close on July 15.

Enjoy it while it lasts?
Of course, the big worry on investors' minds is that the current surge in demand will end. Remember, as I wrote back in April, Joseph Rupp, the CEO of Winchester ammo manufacturer Olin Corporation  (NYSE: OLN  ) , has already stated this surge predictably began just before last year's presidential election and should last "well into the third quarter" of 2013. But the fact remains, the party must stop eventually, right?

But, really, it's extraordinarily difficult to pinpoint exactly when that will happen, and Rupp himself said the last time they experienced demand like this, the drop-off was gradual -- a 10% to 20% fall over a two-year period.

This time, Rupp says, the industry fully expects a similar decline. In the meantime, firearms-centric businesses like Olin and Smith & Wesson are left doing their best to intelligently gauge that demand, being careful not to simply build out their capacity only for it to become useless after sales wane.

Luckily, Smith & Wesson CEO James Debney provided some consolation on the company's earnings conference call by stating that it's not taking a haphazard approach to building out capacity. Instead, Debney says, the company will add it where it "believe[s] it is appropriate, and with a focus on balancing internal capacity expansion with the outsourcing of selected components." This, in turn, provides the flexibility to enable growth while at the same time "providing a layer of insulation should the markets soften."

Foolish takeaway
In the end, I'm encouraged not only by Smith & Wesson's current results but also by the fact that it's wisely managing the business for the long term with a shareholder-friendly attitude -- and absent any delusions that the current boom will go on forever.

With shares currently trading at just 10 times last year's earnings and 8.6 times next year's estimates, then, I'm convinced Smith & Wesson stock represents a fantastic value at today's levels.

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10/22/2014 4:00 PM
SWHC $10.22 Down -0.17 -1.64%
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OLN $25.09 Down -0.42 -1.65%
Olin Corp CAPS Rating: ****

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