Smith & Wesson Blew Away Earnings! What's Next?

On Tuesday, Smith & Wesson Holding Corporation (NASDAQ: SWHC  ) released their earnings report. As a result of the company's better-than-expected metrics for the quarter, shares jumped approximately 4% by the end of the day Wednesday. After seeing its shares jump so high, is there still some value left on the table or is the company not attractive enough for the Foolish investor?

Blowout earnings!
For the quarter, the company reported revenue of $139.29 million, 2% higher than the $136.56 million it reported the same period a year earlier. Although this growth is far from great, it beats out the 0.7% increase that Mr. Market anticipated. The primary driver behind the company's revenue beat was a 27.4% increase in the monetary value of its handgun sales, partially offset by lower sales in its other categories.

This change in product mix, combined with increased revenue, helped the company report earnings per share of $0.28. This is a 33.3% jump compared to the $0.21 that Mr. Market anticipated. However, because of an income tax benefit received during the same quarter last year, the earnings reported declined $0.03 year-over-year.

In addition to seeing rather nice improvement in both the company's top line and bottom line compared to analyst expectations, shareholders also benefited from corporate share buybacks. During the quarter, management bought nearly 7.6 million shares at a weighted-average price of $11. Instead of retiring the $84.4 million worth of shares, management elected to keep them as treasury stock.

What this means is that the value of the shares will be reflected in its balance sheet as a reduction in the company's book value of equity. Though this may seem odd, the decline in equity accounts for the company's reduction in cash and subsequent reduction in shares outstanding. In the event that management decides to sell the shares back to the public, they will reverse this entry and increase their cash balance. In essence, this gives management the opportunity to infuse the company with additional cash if they believe it could benefit operations.

How does Smith & Wesson stack up against its peers?
To get an idea of how significant the company's performance has been, it would be valuable for us to put it up against Sturm, Ruger & Company (NYSE: RGR  ) , another player in the firearms business, TASER International (NASDAQ: TASR  ) , a provider of stun guns, and Olin Corporation (NYSE: OLN  ) , a producer of Winchester firearms. Seeing as how Olin primarily focuses on chemical-based operations, I included only its revenue and operating income from its Winchester segment for the sake of comparability.

Over the past five years, all four companies have seen improvements in both revenue and operating income, but the results for each has been significantly different from the other. For instance, while revenue at Smith & Wesson rose 75.4% from $335 million to $587.5 million, Sturm saw a far stronger 171% increase in revenue from $181.5 million to $491.8 million. This outperformance in the company's top line was likely attributable to a lower revenue base to begin with, but should not be written off as luck.

In juxtaposition, both TASER and Olin saw their sales rise, but at a far slower rate than Smith & Wesson and Sturm. From 2008 through 2012, sales at TASER rose 23.7% from $92.8 million to $114.8 million. Olin performed slightly better over the same time horizon, with revenue rising 26.3% from $489.1 million to $617.8 million.

Although the story for revenue at each company is different, the improvement in each company's operating results is relatively consistent. Over the past five years, operating income for Smith & Wesson has risen from -$73.4 million to $132.8 million. However, if you remove the one-time write-off the company was hit with in its 2009 fiscal year, then its operating income would have risen by 435.5% from a base of $24.8 million.

Even more spectacularly has been the 723% jump in operating income experienced by Sturm. Similarly, TASER saw its operating income rise 332.7% from $5.2 million to $22.5 million. It should be taken into consideration, though, that TASER did experience an operating loss in each of the three years in between 2008 and 2012, so its results could be considered a misnomer. In terms of a growth in operating income, Olin's Winchester segment performed the worst, seeing an increase of only 69.4% from $32.6 million to $55.2 million.

Foolish takeaway
It is impossible to know whether, and to what extent, firearm sales will continue to grow, but we can reasonably conclude that the recent winner in the sector has been Sturm. In addition to growing faster than its competitors, the company has benefited from a reduction in costs relative to sales that has allowed its operating income to increase significantly.

The only downside to investing in this company appears to be its cost. Right now, shares are trading at about 13 times earnings. Though this is far from expensive, it's pricier than the 9 times earnings that the second-best player, Smith & Wesson, is trading for. This disparity in cost suggests an interesting direction investors may take. Taking just the top two firearms companies in the market and setting them side-by-side, investors are left with the option of paying a fair price for a wonderful company or a wonderful price for a fair company. In matters like these, I tend to side with Warren Buffett and go for the first option.

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  • Report this Comment On December 15, 2013, at 5:17 AM, VikingBear wrote:

    Yesterday there was another school shooting, this one in Colorado. It was over in 80 seconds.

    This time there was only one casualty--still too many--because there was a good citizen on duty as an armed resource officer.

    The local authorities responded with tactics that were developed after two mass shootings, and swarmed into the buildings. The shooter chose to stop shooting other people and ate one of his own rounds, successfully.

    It should be noted that he had three Molotov Cocktail firebombs and sufficient ammunition to be a major threat to society; apparently he planned to resist, start fires and hold out for a period of time. He had a shotgun, legally purchased three days ago, which implies prior intent.

    One lone nut ready to die is almost impossible to defend against. The best we can do, apparently, is have armed resource officers on each school site and a policy of rapid, massive response from all law enforcement agencies in the area.

    This is the world we live in. We have to deal with it.

    Our society here in the USA recognizes as a right that its good citizens may keep and bear arms. Persons who abuse this right by committing crimes with weapons are, ideally, locked up for long periods, and no longer allowed to possess arms.

    Good citizens have ready access to purchase arms of multiple types, thanks to the efforts of a number of quality manufacturers, both privately and publicly owned. We are fortunate to live here.

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