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Better Buy: American Outdoor Brands vs. Brown-Forman

By Rich Duprey - Apr 22, 2017 at 1:16PM

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They're both "sin" stocks, but one of them is a more virtuous buy.

One company's business is in a slump, the other is as popular as it's ever been. It should be no contest deciding whether American Outdoor Brands (SWBI 14.49%) is a better buy than Brown-Forman (BF.A 7.88%) (BF.B 2.89%): Whiskey's hot, guns are not.

Yet it might not be so simple. Let's take a closer look to better understand whether liquor is quicker for a profit, or if two smoking barrels are the better long-term play.

A glass of whiskey and a double-barreled shotgun with ammo

Image source: Getty Images.

What does each company do?

Both American Outdoor Brands and Brown-Forman rely upon a single brand for the majority of their revenue. In the case of the former, it's Smith & Wesson; for the latter, Jack Daniel's. Firearms sales account for 87% of American Outdoor's revenue, while spirits account for 95% of Brown-Forman's revenue.

Over the first nine months of American Outdoor Grands' fiscal year, firearms sales grew 30% to almost $584 million, though in the third quarter that had slowed to just a 1.2% gain. Brown Forman's Jack Daniel's products had an underlying net sales gain of 3% in depletions of 9-liter cases (depletions are shipments to wholesalers and retailers, an industry proxy for demand) for the first three quarters of Brown-Forman's own fiscal year.

Growth opportunities

Both companies, however, are more than just their marquee brands. American Outdoor has been on an acquisition spree as it attempts to buy its way into what it terms the rugged outdoors market, a $45 billion to $50 billion market opportunity that's more than three times larger than the $14 billion firearms market.

A UST tarp shelter

Image source: Ultimate Survival Technologies.

Largely parallel to the firearms market, American Outdoor seeks out brands in the rugged outdoors market that have developed a following among their customers, which it can use to "build our business around the consumer we already know." So far, it has bought a knife maker, a laser sights manufacturer, and a survival gear company, and revenue over the first three quarters in its outdoor products and accessories has grown to $90 million as a result. Still, a small percentage of its total revenue during this period of $674 million, but one American Outdoor Brands plans to increase.

Brown-Forman's 1870 founding brand was Old Forester Bourbon Whisky, but along with Jack Daniel's, the distiller has built a portfolio that includes more than 40 spirit, wine, and ready-to-drink cocktails, including some of the best-known brands, such as Finlandia vodka, Korbel champagne, Canadian Mist Canadian whisky, Chambord liqueur, and Herradura tequila.

It has used the industry-leading strength and popularity of the Jack Daniel's name to expand into the flavored whiskey niche with its honey-flavored whiskey, Tennessee Honey, and a cinnamon version, Tennessee Fire. And with good reason: According to the Distilled Spirits Council of the U.S., American whiskey sales have never been stronger, as bourbon, Tennessee whiskey, and rye jumped 8% last year to $3.1 billion. Volume was also higher, rising 6.8% to 21.8 million cases, driven mostly by higher export volumes, which jumped more than 10% in 2016.

Headwinds ahead

The election of Donald Trump as president has roiled many a market, but the impact on the firearms market may have been the most profound (in a negative way; some industries like private prisons and for-profit schools have soared since the election). With the threat of gun control legislation mostly taken off the table for the foreseeable future, gun sales have stalled from their previous red-hot pace. The normalization of demand has led the markets to discount gun and ammunition makers like American Outdoor Brands, Sturm, Ruger, and Vista Outdoor.

Well-dressed man raising a glass of whiskey

Image source: Getty Images.

The impact on Brown-Forman has been more about the potential for harm to its business -- and its stock -- than anything actually happening. Trump campaigned on more restrictive trade policies, such as quotas and higher taxes on foreign goods, which could make it harder for the distiller to sell its liquor internationally if implemented. Underlying net sales in Mexico, for example, have been particularly strong, rising 17% in the fiscal first quarter, 18% in the second, and 14% in the third. And a trade war with our southern neighbor means Brown-Forman could face retaliatory actions against its whiskey, tequila, and other spirits.

Valuation concerns

Despite American Outdoor generating lots of cash, producing heaps of profits, and having a new market to grow into, Wall Street has ignored all that and marked down its stock. At less than nine times earnings and 12 times next year's estimates, the gunmaker's shares are significantly discounted when compared to its industry and the market as a whole. And when you look at the free cash flow it generates in relation to either its market price or its enterprise value, American Outdoor Brands is at a bargain-basement valuation.

Brown-Forman is also a discounted stock, though at 17 times earnings and 24 times estimates, the markdown isn't so clear or dramatic. Yet it also pays a dividend of $0.73 per share that currently yields 1.6%, which, while no barn burner, puts it ahead of dividend-less American Outdoor.

Gun stocks, however, have been rising lately, as the FBI posted strong numbers for March gun buyer background checks. Year to date, gun checks are running about 12% below last year's total, but 2016 was a monster year for gun sales. If you compare it to 2015 -- which itself was a banner year -- this year is actually some 19% higher, meaning the gun industry apocalypse might not pan out as predicted.

The verdict

Both American Outdoor Brands and Brown-Forman are premier plays in their respective industries, and both have considerable strengths with only a few weaknesses. Over the past month or so, the distiller's stock has slumped, falling about 10% as it warned about currency effects and emerging market growth risks, leading it to lower its underlying sales growth forecasts slightly.

Although it pays investors a dividend, Brown-Forman is likely to experience more turbulence in the months ahead, while American Outdoor Brands' stock has already baked in all the calamities Wall Street could conjure. Now that it looks as though those disasters won't befall the gunsmith -- indeed, things could be going far better than previously thought -- its decidedly more discounted valuation makes it the better buy.

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Stocks Mentioned

Smith & Wesson Brands, Inc. Stock Quote
Smith & Wesson Brands, Inc.
$16.44 (14.49%) $2.08
Brown-Forman Corporation Stock Quote
Brown-Forman Corporation
$71.51 (2.89%) $2.01
Sturm, Ruger & Company, Inc. Stock Quote
Sturm, Ruger & Company, Inc.
$66.06 (2.72%) $1.75
Brown-Forman Corporation Stock Quote
Brown-Forman Corporation
$70.47 (7.88%) $5.15
Vista Outdoor Inc. Stock Quote
Vista Outdoor Inc.
$30.73 (2.40%) $0.72

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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