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Feel Lucky? Aim at Smith & Wesson

By Igor Greenwald on April 5, 2013

The CEO of gun maker Smith & Wesson (NasdaqGS: SWHC)  kicked off last month’s conference call with an expression of sympathy for victims of Newtown, just as the CEO of Sturm Ruger (NYSE: RGR) had done before him.

Then he got down to the business of discussing record profits and sales running so hot the company can’t keep up.

For some, most notably some high-profile public pension plans, the linkage between gun massacres and weapons makers has become too much to stomach, leading to a divestiture of gun stocks from their portfolios.

The private-equity group Cerberus Capital quickly announced plans to sell Freedom Group, the maker of the Bushmaster semi-automatic rifle used in Newtown, under pressure from investors including the California State Teachers Retirement System.

For others, though, the record profits part will be the only one that counts. Cerberus has no shortage of bidders willing to pay up to $1 billion for Freedom Group, the Financial Times reported recently.

And then there’s Smith & Wesson, legendary armorer of Dirty Harry. The stock fetched $3 a share in December of 2011 and topped out above $11 the week before Newtown. Now it’s licking its wounds below $9. The inability to sustain a recovery rally from the knee-jerk selling after Newtown looks all the more curious given the gung-ho demand from gun enthusiasts.

There’s only one American craze, bubble, and obsession worth discussing at the moment. Bruce Springsteen sings of it. Las Vegas peddles it as entertainment. It shapes our politics and pervades our culture and history. 

That was me writing about the personal arms race a little more than a year ago. Back then, the FBI’s National Instant Criminal Background Check System was processing 1.2 million requests, mostly from gun stores, per month. Last month, it handled 2.2 million. Which admittedly is not as many as the 2.8 million in December or 2.5 million in January, when America went on a semi-automatic shopping rampage amid a gun control debate that’s been tremendously helpful to Smith & Wesson’s bottom line.

So helpful that in the three-month period through January Smith & Wesson’s sales shot up 39 percent while net income more than tripled, as the company ran its plants at full capacity for the fourth straight quarter. The order backlog has doubled since October. Smith & Wesson raised the upper bound of its annual sales forecast by 15 percent and said earnings per share in the current quarter will be up some 50 percent on a year ago, and 30 percent higher than analysts had been expecting back in February.

Gross margin improved to 37 percent from 31 last year as the company kept costs in check despite the production ramp. The profits will continue to be plowed into share buybacks that should reduce the float by some 10 percent by June, from November.

And yet executives acknowledged that the sales backlog could have been inflated by dealers scrambling for inventories, so Smith & Wesson has developed contingency plans for a variety of scenarios. It plans to defend its margins should sales slow. Analysts have similar concerns, as they eye the post-Newtown sales spike.

So the shares are down 16 percent in a month, burrowing below the 200-day moving average. The stock is now priced at 7 times the earnings for the fiscal year ending  this month, and 8 times the somewhat lower consensus for the coming year.

This looks too cheap for a company with a valuable brand, booming sales and promising gains in  the polymer pistol and rifle market segments. Sensible restrictions adopted in Connecticut, New York and Colorado after recent tragedies pose no threat whatsoever to Smith & Wesson sales, which are already subject to background checks. Meanwhile, the emotional gun control debate continues to motivate some buyers to expand their arsenals as a political and personal statement.

Inevitably, their spending on new guns will cool, a likelihood that already seems to have been priced into Smith & Wesson shares. And, just as inevitably, future Newtowns await, followed by even larger private arsenals.

Igor Greenwald is an investment analyst with The Energy Strategist.

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