"If I had the cash, why would I need a loan?"
That may sound like a rhetorical question -- or perhaps a joke overheard in cocktail party conversation among bank loan officers. Now, it's also a pretty good question for Smith & Wesson (NASDAQ:AOBC) shareholders to start asking themselves.
Late last month, you see, Smith & Wesson issued a curious press release. Out of the blue, the company announced that it had just doubled the size of its revolving line of credit from $175 million to $350 million. The company also tripled the size of its "option to further expand its credit commitment" from $50 million to $150 million. In total, the two actions give Smith & Wesson access to $500 million in unsecured credit from its lenders -- for purposes unknown.
"Sure, we'll give you a loan ... but only if you don't need one"
As Smith & Wesson explains, the recent boom in gun sales has left the company in an admirably strong financial position, featuring "an exceptionally strong balance sheet", with plenty more cash flowing in the door every day. According to data from S&P Global Market Intelligence, Smith & Wesson currently boasts $215 million in cash on its balance sheet, balanced against only $165 million in debt.
At the same time, the company's $112 million in trailing net profits don't come close to reflecting the amount of cash pouring into its coffers. Over the past 12 months, Smith & Wesson has actually generated in excess of $150 million in free cash flow. That's nearly twice the amount of cash profit the company generated in 2015.
Simply put, Smith & Wesson is currently swimming in cash. The last thing the company needs right now is to take out a loan. So why does it appear to be doing just that?
Reading the tea leaves
Two possibilities spring to mind. With the election underway, there's a distinct possibility we will soon see a pro-gun control president enter the White House (albeit, to replace another just as pro-gun control president leaving it). Should such an event foreshadow tightened gun regulation, and reduced gun sale revenue over the next four years, Smith & Wesson could anticipate the imminent need to access a bit of cash to tide itself over until the next presidential administration.
But there is another reason Smith & Wesson could be getting ready to hit up its bankers for a loan -- and it's one that might prove lucrative for investors. Consider this: When President Obama took office eight years ago, gun owners had similar fears of imminent gun regulation -- fears that never really panned out.
If history repeats itself, and the new administration ushers in a new wave of gun buying next year, then far from suffering a revenue crunch, Smith & Wesson might be about to enjoy another banner year of sales. In anticipation of increased demand, Smith & Wesson could be preparing to double down on its bread-and-butter business, or perhaps buy a rival -- so as to increase its share of a gun market that's ready to boom.
The upshot for investors
With plenty of cash on hand, little debt, and a business generating even more cash as time goes by, you might think Smith & Wesson is already well positioned to make such a purchase -- and you'd be right. Still, more money cannot hurt, and might even become a necessity if Smith & Wesson rival Sturm, Ruger (NYSE:RGR) starts bidding against it. After all, Sturm, Ruger is similarly debt-free. and cash rich. Should these two companies find themselves shooting at the same targets, Smith & Wesson's extra $500 million would be convenient to have on hand.
Now am I right about my guess? It's hard to be 100% certain. But given there are only two possible reasons for Smith & Wesson preparing to take out a big loan, I'd say the odds are at least 50-50 -- and so are the odds we'll see Smith & Wesson make at least one new acquisition before 2017 is out.