American Outdoor Brands (SWBI 1.44%) surprised the market in August by reporting stronger-than-expected results for the first quarter of fiscal 2019. As a result, its stock gained 60% over the ensuing month. After having been beaten down by a weakened gun market, the company reported robust organic sales growth of 10% for the first quarter and turned a $0.04-per-share GAAP loss in the year-ago period into a $0.14 profit this time out.
The firearms and outdoor gear manufacturer will announce its fiscal second-quarter results on Dec. 6. Investors are wondering whether American Outdoor Brands will have a repeat performance or if they should be worried about what's to come.
There are indications of rising firearms demand, but maybe not enough to offset the industry's structural weakness. Image source: Getty Images.
Adjust your expectations
Looking at FBI data over the last three months, there is cause for hope. Background checks through the agency's National Instant Criminal Background Check System are up 3.2% from the year-ago period and are 6% higher than the previous quarter. While not an exact proxy for gun buying, the system is often seen as an indicator of demand.
When looking at the adjusted data from the National Shooting Sports Foundation, which removes duplicate background checks from the FBI numbers (like checks of existing permit holders), the data tells a somewhat different story: Year over year, background checks are down 9%. Yet on a sequential basis, they're actually 10% higher.
That bodes well for American Outdoor Brands and rival Sturm, Ruger, as it indicates increasing interest for gun purchases on both an aggregate and adjusted basis. But it should be noted that the summer months are typically slow sales periods, and demand tends to pick up as we enter the hunting season.
Artificial inflation
Three months ago, American Outdoor Brands forecast second-quarter sales to rise anywhere from 1% to almost 8% from the year-ago period, which would build on the gains from the first quarter. However, that quarter's growth was mostly predicated on a change in accounting standards that helped boost sales. Had the gunmaker used the same standards in the first quarter that had been in effect last year, sales would have been relatively flat. And since unit shipments of handguns were actually down year over year in the first quarter, the explosive reaction to American Outdoor's earnings report was a bit overdone.
Furthermore, prior to the introduction of its M&P 2.0 pistol in 2017, the firearms manufacturer ran targeted promotions to clear out inventory of the older model. This moved a lot of product but hurt margins. That wasn't repeated this year, so average selling prices were up year over year, boosting profit margins.
That's not going to repeat in the back half of the calendar year. American Outdoor Brands warned that gross margin is going "to be a bit lower" in the second and third quarters of fiscal 2019 than in the first quarter because the company is going to be promotional again for the fall and Christmas seasons. Meanwhile, operating expenses are going to be higher for the rest of the fiscal year than they were in the first quarter.
So while the company may still get a revenue boost from the new accounting standard, its profits aren't going to be as good as they were in the first quarter. American Outdoor Brands guided to adjusted earnings per share of $0.11 to $0.15 for Q2. For comparison, adjusted EPS was $0.11 in the prior-year period and $0.21 in the first quarter of this fiscal year.
The final verdict
The firearms market is exceptionally weak, which American Outdoor Brands admits is "likely as a result of reduced political pressures on firearm laws and regulations." The November elections didn't change that calculus all that much, suggesting that American Outdoor Brands and other gunmakers will continue limping along for some time to come.
