Smith & Wesson Misses the Mark

Smith & Wesson reported a better-than-expected first quarter, but investors are selling off the stock as the gun maker’s second-quarter guidance missed the mark.

Late Thursday, Smith & Wesson (ticker: SWHC) reported earnings of $26.5 million, or 40 cents a share in the quarter ended July 31, up from 27 cents a share a year earlier. Revenue grew 26% to $171 million. Analysts were looking for the company to earn 36 cents a share on $165.3 million in revenue.

Investors, however, were concerned with Smith & Wesson’s outlook for the current period: The company said it now expects to earn between 20 cents and 22 cents per share from continuing operations in its second quarter on revenue of $135 million to $140 million. Analysts were looking for the company to earn 29 cents a share on $143 million in sales. Its full-year forecast was in-line with expectations.

The stock dropped 8.3% to $10.53 in Friday morning trading on the news, but we think bargain hunters should beware.

While the quarter was a strong one, Smith & Wesson’s guidance shows that the company may see sales slow, as the flurry of purchases made by consumers wary of stricter gun legislation tapers off.

“Widespread consumer fears of such tightened gun control drove a sharp surge in industry demand earlier this year. However, we fear such a surge will prove to be short-lived, as such sharp sales increases are likely driven by consumers pulling forward their purchases from future quarters,” wrote Wedbush Securities analyst Rommel Dionisio, who maintained his Neutral rating on the stock in a note last week, and thinks the shares should trade at $10.

To be sure, there were bright spots in the report, as the company appears to continue to take market share and its gross margin expanded to 42.6% from 37.7% on favorable product mix and production efficiencies. Yet that will do little to help Smith & Wesson’s stock if Wall Street has gotten too optimistic about the sustainability of Main Street’s recent appetite for firearms.

KeyBanc Capital Markets analyst Scott Hamann also thinks the shares would be fully valued at $10; he downgraded the stock to Underweight recently, writing that he projects retail demand, “to meaningfully decelerate into the fourth quarter of 2013 (estimated -18%) and the first quarter of 2014 (est. -30%) as comparisons become increasingly difficult against diminished political noise and a retail environment that appears to be returning to normal demand and inventory levels, based on recent channel checks.”

Certainly, the stock will likely see some bounce off today’s lows, and at eight times forward earnings, it doesn’t look pricey. Nonetheless, if sales seem poised to retreat from recent strength, there would seem to be little catalyst for valuation to expand. “We believe shares of SWHC should trade at a 50% discount to the peer group average,” noted Wedbush’s Dionisio.

Although Smith & Wesson shares have outperformed many peers and the broader market year-to-date, they are trailing the Standard & Poor’s 500 over the past 12 months. The thinly covered name doesn’t have a consensus for long-term earnings growth and doesn’t pay a dividend.

It seems inevitable that political rhetoric will once again return to gun control in the next election cycle at the latest. Yet absent any more immediate regulatory push – and any apparent appetite in Congress to regulate gun sales – that it may be difficult for Smith & Wesson to outperform as gun sales return to a more normalized level, especially given the stock’s recent rally.

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