Description

AOBC

Long AOBC (American Outdoor Brands Corp), today (Monday April 16)’s closing price is $10.85/share.

American Outdoor Brands Corp (henceforth called AOBC) is a leading US manufacturer of guns and related consumer products. AOBC has not been written up on VIC before, because it wanted a new life at the previous gun sales cycle peak, did a bunch of acquisitions (of companies selling shooting related stuff, that’s where the “Outdoor Brands” in AOBC came from) and last year renamed itself to AOBC: it used to be called Smith & Wesson (ticker SWHC). mack885 wrote about SWHC on December 14, 2012; his writeup contains many useful information and is worth reading.

AOBC’s fiscal year end is April 30, so the most recent available quarterly information is 2018 Q3, and we will have 2018 Q4 report about 2 months later on June 28. The company changed its ticker from SWHC to AOBC on January 1, 2017, after acquiring several companies selling firearm related products. Before these acquisitions almost 100% of the business is making firearms. As of now, the company reports in two segments: (A): firearm: which operates under the Smith & Wesson name; and (B): outdoor: Battenfeld Technologies, BTI Tools, Ultimate Survival Technologies, etc; this segment consists of mostly recent acquisitions.

The firearm segment operates under the Smith & Wesson name. Smith & Wesson has been making guns for 166 years since 1852. It’s most famous for making revolvers, but its lasting success is due to its ability to continuously coming up with new hit products. Smith & Wesson is one of the largest gun makers in US. The domestic non-military firearm industry is about $2.8B for handguns and $1.8B for long guns (estimated based on industry shipment), with S&W having market share 19.6% (handgun) and 10% (long guns) based on 2015 data. The US firearm industry has grown at 11% from 2010 to 2015.

The outdoor segment consists of a varieties of businesses selling firearm related products like: gun barrel, dazzle loaders, hunting and shooting accessories, extendable tree saws, high-quality knives, tactical flashlights, etc, etc (you get the idea from this sample list). The total market here is much larger than the firearm industry: based on Outdoor Industry Association’s 2015 report, the annual US domestic hunting and shooting market is about $16B, the annual US domestic outdoor recreation market is about $90B - $100B (which includes hunting and shooting, camping fishing, trail sports, wildlife watching). AOBC’s market share here is tiny. Gross margin in the outdoor segment is generally much higher than the firearm segment. Part of the company’s strategy is to expand into adjacent and complementary markets through acquisition (the company pays no dividend); all acquisitions in the past few years are for companies selling gun related products; so far these acquisitions worked pretty well.

Let’s look at the most important factors affecting the firearm industry:
(1): The District of Columbia vs Heller case in 2008 basically guarantees that the firearm industry is here to stay. This case rules that citizens have the right to possess firearms regardless of whether they are in service of a militia. Therefore a primary argument (based on their interpretation of the 2nd amendment) of the anti-gun activists is removed.
(2): NICS (national instant criminal background check system): Purchasing firearms require some criminal background check. The monthly NICS number is generally considered the best available proxy for consumer demand for firearms.
(3): Election results affect firearm sales in a big way. The dynamics here is interesting and is quite different from most other industries in that a pro-gun-ownership administration (republican party) is bad for gun sales and a anti-gun-ownership administration (democrat) is good for gun sales. This is because people usually will store up guns and ammunitions if they expect upcoming tighter gun control policies. This pattern is very clear if you check historical data: gun sales and industry profit during democrat administration [1993, 2000], [2009, 2016] are much higher than during republican administration [1980, 1992], [2001, 2008].

Now let’s come back to the current situation. AOBC’s performance was atrocious during the past two years. The stock price was declining non-stop from its August 2016 high of $29/share and has dropped more than 60% to the present $10.85/share. Anecdotally this coincides with trump being elected thus once again verifying the third point above. Also the NICS numbers were trending lower since 2016:

https://www.fbi.gov/file-repository/nics_firearm_checks_-_month_year.pdf/view
 
 However, I believe now we are at an inflection point. Let’s look at Q3 data first:
(1): The gun sales declining situation has stabilized and inventory condition has improved. AOBC does not sell guns directly to consumers; all sales are done through law enforcement agencies and federally licensed firearm wholesalers and retailers.
“In out Q3, background checks for handguns declined 8.8% while our unit shipped into distributors and retailers declined 38.3%. Despite that decline, we believe we maintained our share leadership position in the consumer handgun market largely because retailers fulfill consumer demand for our firearms using their existing inventory of our products. For this reason, we also believe our unit sales relative to NICS results indicated channel inventory reduction efforts by wholesalers and retailers were successful in the quarter. Gross margin in our firearm segment in Q3 were 23.4%.” —- James Debney (CEO)
(2): Outdoor segment: revenue grew 10.9% year-over-year (a combination of inorganic and organic growth). Gross margin 48% is much higher than the firearm segment; so far the acquisition strategy in this segment is working very well.
(3): Manufacturing workforce has been reduced by 25% in the past 12 months. This should lower fixed cost and improve margin.
(4): Management’s guidance for FY2018 revenue is $597M - $601M, with non-GAAP(excluding tax reform benefit and amortization cost related to acquisitions) EPS $0.31 - $0.33.

TTM EPS $0.33 for a stock price of $10.85 is pretty abysmal. But this is because the firearm segment margin for the past 12 months is much lower than normalized numbers due to two factors:
(A): Due to declining demand, wholesalers / retailers have to offer bigger discount to unload their inventory.
(B): Fixed cost as a percentage of total revenue is higher because of redundant workforce built up in the past few years. (FY2015, FY2016, FY2017 sales numbers are $552M, $723M, $903M).
Now these two adverse factors have all be relieved (See (1) and (3) in the previous paragraph). Also the outdoor segment has much higher margin and offers great growth potential; it currently accounts for 25% sales and 40% of growth profit.

core thesis
In Q3 report, management guides FY2018 revenue to be about $600M, and expects demand to be flattish in the next 12-18 months; inventory situation has greatly improved; outdoor segment is growing. NICS number is already trending up YoY in March 2018. Now republican guys are in office so things can only turn better not worse from the political angle. Firearm industry is a growing industry on a long term basis. The company is expanding successfully into outdoor segment which has much higher margin. Based on these factors, I believe the company is able to do >= $600M sales on a normalized basis with margin at historical long term levels. Let’s notice that the company is reducing share count continuously (it currently has a $50M buyback authorization). To figure out how much the company is worth, let’s look back to [2012, 2015]: During this 4 year interval, the average sales is $544M with average net income $58M, average after-tax ROIC (defined as netIncome/tangibleCapital) is about 25.5%. Assume similar margin, $600M sales means normalized net income of 58 * (600 / 544) = $64M; the current mktcap is $584 so normalized P/E is 584/64 = 9.12. I think a sub-10 normalized P/E for a 25% after-tax-ROIC business with little debt in a growing industry is unlikely to lose money. Also with noting that during 2012 to 2015 the stock price has always been >= $10.5/share.


Disclamer

This report is for information purpose only and does not serve as investment advice.

Catalyst

(1): we have a republican majority government, any election change would be good.

(2): the effect of inventory improvement, workforce reduction will be shown in margin in the next few quarters

(3): expansion to outdoor segment improves margin