Introduction / Thesis

Sportsman’s Warehouse is a retailer of outdoor sporting goods supplies. Along with most other retailers, SPWH shares have recently been trading at multiyear lows on continued fears of Amazon domination. Unlike most retailers, it is also a retailer of guns. Most gun stocks have similarly been trading near multiyear lows due to the hangover from surge buying in 2016 on expectations of a Democratic Presidential win. These two factors along with a little leverage have combined to make SPWH a very out of favor name.

Some of this treatment is justifiable, primarily because the company has had difficulty showing consistent same-store sales growth for much of the last four years. Much of this comp weakness is clearly attributable to gun cycle volatility, though some is not. Even so, we believe many of the factors depressing this metric are likely to offer a reprieve and the company may again begin reporting positive comps soon. In the event they do so, the company’s <9x PE on 2017’s likely trough EPS will prove too low.

Positive company attributes

Guns and ammunition comprise ~30% of the sales mix and is thus resistant to online encroachment. These sales also drive walk-in traffic and spur sales of other consumable items. Customers frequently like to touch and feel these products before they buy and they also carry a consultative sales aspect.

Unique no-frills store model employs an everyday low pricing strategy which makes the company price competitive with online and brick and mortar peers. Limited markup and promotional activity also limits inventory risk and gross margin volatility. Additionally, the store model has also proven adaptable and successful at smaller sizes (~15 – 35k sq. ft. vs many BassPro/Cabelas in excess of 100k sq. ft.) where its larger peers have struggled. This means the company can be successful in smaller metro areas and provides it a greater runway for new store growth.

A focus on return on capital is appropriately the principle driver behind the company’s growth strategy. In part because of the company’s success with smaller boxes, SPWH stores can target strip centers and smaller metro areas. It is also worth noting the company and many of its stores are young and thus not subject to many undesirable leases.

Management execution has been solid, despite a very competitive environment. Except for 4Q 2016 on the back of the election, management has hit their quarterly guidance every quarter since being public. Management also appropriately slowed new store expansion in 2017 due to comp softness, which will also be cash generative.

Business overview

SPWH is an outdoor sporting goods retailer operating 86 stores, primarily in the Western United States, although it is gradually expanding into the South and Midwest. The average store size is 42,000 square feet and the model has proven adaptable to both standalone locations and strip shopping centers. 62% of their markets currently lack another nationally recognized outdoor specialty retailer (e.g. Bass Pro/Cabelas, Field & Stream and Gander Mountain) implying their primary competition is smaller specialty retailers (“mom-and-pops”) which they estimate comprise 65% of the total outdoor specialty market. SPWH strives to recreate the localized feel and high touch service of these mom-and-pops while offering everyday low prices and expansive product breadth (140,000 SKUs) that is competitive with national retailers.

The product offerings are well suited to drive repeat business and offer some resistance to online retailers such as Amazon. Regulatory restrictions create certain structural barriers to the online sale of approximately 33% of revenues, such as firearms, ammunition, certain cutlery, propane and reloading powder, giving them a measure of protection from online-only retailers such as Amazon. Consumable goods (e.g. ammunition, fishing tackle) made up 36% of unit sales in fiscal year 2016 and 20% of dollar sales and tend to drive repeat traffic. According to an internal survey, 67% of customers visit their stores seven or more times per year.

Key initiatives include e-commerce and the loyalty program. During fiscal year 2016, the e-commerce platform generated total sales of $9.3 million, or 1.2% of total sales, but received greater than 17.0 million visits. The loyalty program (launched in fall of 2013) had 1.5 million members as of 3Q17, up 30% in the last year, and sales from loyalty members make up 45% of total sales. Importantly, SPWH is not an entrenched incumbent and accordingly is more adaptable to the challenges of today’s retailing environment. More than half the stores were opened in the last 4 years and as such reflect the current strategic vision of management.

Management strongly focused on ROIC w/ large store growth opportunity

The current management team was brought on following the 2009 bankruptcy and has a strong track record of growing the store base while maintaining a high ROIC. SPWH added 9 stores/year in FYs 2014-16 and 12 stores in FY 2017. They plan to add 5-9 stores/year going forward including 5 in FY 2018. For the 29 stores opened since 2010 that have been open for a full twelve months, they achieved an average four-wall adjusted EBITDA margin of 13.5% and an average ROIC of 81.7% excluding initial inventory cost (and 30.1% including initial inventory cost) during the first twelve months of operations. The CEO and CFO have a small part of their compensation tied to company growth and new store return on invested capital for fiscal year 2016, and the CEO also has a somewhat larger portion of his compensation determined by the results of the company’s adjusted fully-diluted EPS. Besides 4Q16 (Trump election), they have hit quarterly guidance each quarter since going public.

PE sponsor Seidler Equity bought them out of bankruptcy and brought them public in 2014. They are still the largest single holder with ~12% of CSO but no longer own a controlling interest. Insider ownership is low at just 2.57% though we note the CFO has recently made a few modest purchases.

Inconsistent comp growth, L4Y

Note: These are national adj NICS figures and are unadjusted for the SPWH footprint. Adj NICS data is also presented on a calendar basis, whereas SPWH comps are for the company’s FY ending in January. Accordingly, the comparisons are not perfect, particularly at large trend shifts as in 2017.

Management has guided new stores to a comp ramp of 10%, 8%, 6% and 3% in years two through five before settling into a mature comp of 2%. At present, we believe 15%, 12%, 11%, and 19% of the store base resides in comp years two through five, respectively, which currently implies a “normal” comp growth rate of ~4-5% on the existing store base. We believe much of the weak comp growth since 2013 can be largely explained by volatility in gun sales (particularly relevant in 2013 and 2017) and to a lesser degree industry expansion, particularly amongst the bigger names such as Bass Pro Shops and Cabelas. Both of these headwinds are likely to offer a reprieve in coming quarters. We will first cover the industry  

expansion.

Competitive openings - Competitive openings have affected roughly 20% of the store base for the past three years resulting in an estimated drag on SSS of 170 basis points in FY 2016 and approximately 100 basis points for FY 2017. This should diminish further in 2018 and 2019 as the industry is in the midst of rationalization, evidenced by the recent Gander Moutain bankruptcy and Bass Pro Shops / Cabelas merger. Bass Pro/Cabelas reportedly has a 6x ND/ebitdar and is unlikely to show significant store growth soon. The industry consolidation combined with lower gun sales has resulted in an increased promotional environment which has been a drag on SSS throughout much of 2017.

Gun Sales - SSS growth was negative in 2013 and 2014, flattish in 2015 and 2016, and is expected to be negative again in 2017. This is admittedly the most concerning aspect of the story. We believe a large part of this is attributable to weak growth in gun sales, proxied below by Adjusted NICS Background Checks. Gun sales were down in 2017 due to the election cycle, but we expect gun sale declines to moderate in 2018. A similar dynamic occurred in 2014 following a spike in purchases in 4Q12 and 2013 in the wake of the Sandy Hook shooting.

Gun sales are not only important to SPWH because roughly 50% of the product mix is composed of hunting and shooting, but also because hunting and shooting tends to drive foot traffic through the store. The hunting and shooting section is strategically located at the back of the store and is associated with a large number of consumable goods such as ammunition.

Adj NICS data – Adjusted NICS Background Checks have grown by an average of 5.1% annually since 2000 and can roughly be split into two periods:

Jan 2000 – Sept 2008 (pre-Obama), when they averaged 2.2% annual growth

Oct 2008 – Nov 2016 (Obama), when they averaged 9.9% annual growth

Through calendar year 2017 background checks are down 8.6% from 2016, portending a weak start to the post-Obama era. That said, 2.2% seems a reasonable assumption for annual trend growth going forward, adding to the .7% US population growth due to growing participation in shooting sports, particularly amongst women and children.

We believe gun sales are likely to recover in 2018 given easy comps from 2017. We also note Adjusted NICS Background Checks have not run negative on a year-over-year for more than 12 months consecutively in the history of the data series, going back to 2000. December 2017 currently marks the seventh consecutive month of negative year over year growth rates.

Recent updates

In 2017 the company prudently slowed its store growth rate due to the soft comps and also to manage a somewhat elevated leverage profile. In 1Q 17, the company also renegotiated some of the covenants in its term loan and expanded its leverage limits to give it further breathing room. At 3Q 17, the company had 2.8x LTM net debt/ebitda and ~5x debt/ebitdar. Finally, the company has been a full tax payer, paying a ~39% tax rate which should move to ~26% in 2018. Tax cuts should also be a boost to demand

driver for its customer base.

Valuation

Bear: 2018 sales growth comes in at +3% on the back of new store maturation though still deterred by a -2% comp and we arrive at a 2018 EPS estimate of $.68. We assume a still penal 8x multiple in part to account for the leverage and a concept with no comp growth and arrive at a $5.44 price target.

Base: 2018 sales growth comes in at +6% aided by a barely positive comp of +1% comp and we arrive at a 2018 EPS estimate of $.71. We assign a 10x multiple to arrive at a price target of $7.10.

Bull: 2018 sales growth comes in at +8% aided by comp growth of +3% and we arrive at a 2018 EPS at $.74. We assign a 12x multiple to arrive at a price target of $8.88.

Risks

Gun market growth remains sluggish.

Competitive risk grows as BassPro/Cabela, Field & Stream and/or Gander Mountain now owned by Camping World become more aggressive. Online risk accelerates and gross margins compress, or the cost to compete grows and reduces operating leverage.

Leverage of 2.8 LTM net debt/ebitda becomes a deterrent to company plans and further impairs the trading multiple.