Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
"It's clear the stock market doesn't understand the gun market." -- Motley Fool "gun stocks" specialist Rich Duprey
That was my Foolish colleague, Rich Duprey's assessment of Wall Street's reaction to a bad earnings report from American Outdoor Brands (NASDAQ:AOBC) last month -- and it doesn't bode well for this morning's news, which features three new stock ratings from researchers at boutique investment banker Aegis Capital.
This morning, analysts at Aegis announced they are initiating coverage of American Outdoor Brands, Sturm, Ruger (NYSE:RGR), and Vista Outdoor (NYSE:VSTO). Two of these stocks they like, and one they do not. But if "the stock market doesn't understand the gun market," should you pay any attention to these ratings at all?
Read on and find out.
1. Aegis Capital's sole "sell"
Let's start at the bottom with Vista Outdoor, Aegis Capital's least favorite stock in the guns group. Despite initiating coverage of Vista Outdoor with a "hold" rating and a $26 price target, Aegis predicts that Vista Outdoor stock will actually rise 12% in share price over the next 12 months.
Why? Vista isn't the highest profile of the "gun stocks," but whether you know it or not, you've probably heard of the company before. Vista owns both long-guns manufacturer Savage Arms and optics specialist Bushnell. According to StreetInsider.com, Aegis considers Vista Outdoor a "market leader" in guns, which, combined with the analyst's expectation of a 12% rise in stock price, doesn't really jibe really well with Aegis's decision to assign Vista a "hold" rating.
And here's another thing that doesn't jibe: Vista Outdoor stock is cheap! With only a $1.3 billion market capitalization, Vista told investors earlier this month that it expects to generate positive free cash flow of as much as $200 million this year, which would price Vista stock at just 6.5 times cash profits. Throw debt into the mix, and the company's enterprise value-to-free cash flow ratio rises to about 11.5. But even that valuation will look cheap if Vista hits Wall Street's expected earnings growth rate of 25% over the next five years. Far from "holding" Vista, I'd give this stock serious consideration for a "buy" rating.
2. Outdoors look great at American Brands
Aegis's other "outdoor" pick today is American Outdoor Brands -- and this is one gun stock Aegis likes. Predicting "favorable LT growth trends in firearms" in general, Aegis believes we could see gun orders begin to improve as early as "fall 2017."
Incidentally, that would also be about the same time American Outdoor Brands announces its first financial results of fiscal 2018. (Fiscal Q4 2017 earnings came out at the end of June, which suggests Q1 2018 earnings should arrive in late September or early October). This provides a clear catalyst for American Outdoor Brands stock to be one of the first gun stocks to rebound. If the gun market looks likely to improve in the fall, you would expect management to comment on this in its earnings release -- and perhaps even raise guidance in anticipation of stronger gun sales.
With American Outdoor Brands stock selling for less than 8 times earnings today (and 11.5 times trailing free cash flow), with earnings on the horizon and gun buyer demand potentially propitious, now seems like a fine time to pick up some American Outdoor Brands stock for cheap.
3. Sturm, Ruger could be cheap too -- but keep it quiet
Aegis's third and final gun stock initiation today is Sturm, Ruger -- and here, Aegis is echoing some of my own thinking. As I argued earlier this year, 2017 could be the year that gun stocks benefit from a new law working its way through Congress.
Dubbed the "Hearing Protection Act," this new law aims to roll back restrictions on the purchase of "silencers" for firearms (aka "suppressors"). Currently, silencers are legal to purchase in 42 states, but only with payment of a steep federal tax and subject to onerous waiting periods. Arguing that firearms suppressors are good for target shooters' hearing, though, and they also reduce the public nuisance from noise pollution at shooting ranges, Congress wants to make it easier for consumers to buy silencers.
Back in January, I predicted that such a law would be great news for Sturm, Ruger, which makes and sells silencers. Aegis, too, believes that "possible passage of favorable legislation on sound suppressors would be a "fundamental" catalyst for Sturm, Ruger stock. Single-handedly, it could turn around Sturm, Ruger's fortunes after the stock suffered more than a 13% sell-off post-earnings earlier this month.
The upshot for investors
That being said, investors need to be aware of two things in particular: Firstly, passage of the Hearing Protection Act is by no means assured. Opposition to the law will be vocal from gun-regulation advocates who fear wider access to silencers will spark an increase in gun crime.
At the same time, investors need to be aware that at 11 times earnings, and nearly 20 times free cash flow, Sturm, Ruger stock is arguably the most expensive of the big three gun stocks, even as estimates for the company's long-term growth rate are hardest to come by. If you ask me, while Aegis rates Sturm stock a buy, it's actually the one gun stock I'd be most likely to hold while awaiting further clarity.
Vista Outdoor stock and American Outdoor brands, on the other hand, both look honest-to-goodness cheap to me. If you're looking to buy a gun stock, I'd look at those two first.