Gun sales are in the crosshairs as Wedbush downgrades Smith & Wesson stock. Image source: Getty Images
Gunslinger Smith & Wesson (SWHC 0.71%) reports its fiscal fourth quarter and full-year 2016 earnings results on Thursday, but one analyst isn't waiting around to hear the bad news. On Friday, just ahead of the weekend and well before Smith & Wesson issues its report, the analysts at Wedbush reduced their price target for the stock.
Predicting a sales slump ...
What has Wedbush so worried about Smith & Wesson? After conducting "recent channel checks of 30-plus big box and independent firearm retailers," Wedbush says it sees signs of a sales slump forming.
Smith & Wesson, says the analyst, enjoyed "sizable growth" in sales across most of the fiscal 2016 fourth quarter (a fact that bodes well for the company hitting expectations on Thursday, by the way). That's the good news. On the other hand, though, sales growth began to decelerate toward the end of the quarter, and as the fiscal 2017 first quarter began in May, sales actually seem to have flatlined.
... and a quick revival
Now mind you, Wedbush isn't saying that this is a reason to sell the stock. Retaining a "neutral" rating on the stock, the analysts pulled their price target down to $23 -- but even that implies a chance for some small growth in the stock over the course of the next year. Wedbush believes Smith & Wesson sales stalled in May due to a lack of sufficient inventory to satisfy demand. As new guns are manufactured and shipped, the analyst actually believes that sales could recover as the first quarter progresses.
... followed by another slump
So why not upgrade the stock and encourage investors to take advantage of the 12% decline in stock price that Smith & Wesson has suffered month-to-date?
Because what Wedbush sees happening in the short-term differs markedly from what it forecasts for the rest of the year.
Over the course of fiscal 2017, Wedbush is predicting a 7% decline in nationwide NICS background checks (a proxy for gun sales), which, when combined with declining profit margins, will hurt Smith & Wesson's profits over the coming year. Wedbush believes that when Smith & Wesson reports earnings on Thursday, it will confirm this downbeat view by lowering guidance for both revenue and earnings for full-year fiscal 2017.
What it means for investors
So what should investors make of Wedbush's warning? Here's how I look at it: Right now, Smith & Wesson stock sells for less than 15 times trailing earnings -- and less than 9 times free cash flow. The stock pays no dividend, but according to analysts polled on S&P Global Market Intelligence, is generally believed to be capable of growing profits at better than 12% annually over the next five years. To me, these are pretty cheap-sounding numbers, and they suggest Smith & Wesson stock is a bargain.
Granted, if Wedbush is right about growth decelerating, that suggests the stock may not be quite as cheap as it looks. But growth would have to decelerate a lot to make a valuation of 9 times free cash flow look expensive. And when you get right down to it, what are the chances that growth will decelerate in the middle of a hotly contested election year, with one party probably advocating greater restrictions on gun sales, and the other warning voters that such regulation will be enacted if the former party wins?
I'd put those chances no higher than the chances for an analyst who brought a knife to a gunfight. Smith & Wesson stock looks cheap to me. That's my story, and I'm sticking with it.
