It's time to catch a falling knife - a bowie knife in this case.

Sportsman’s Warehouse is a busted IPO. The stock priced its April IPO at $9.50, below the initial $11-$13 range. With a couple of brief pauses, it’s been straight down ever since, hitting a low of $5.50 before reporting Q2 results recently and rebounding to $7, but is back to $6.30 already. Despite some very real issues facing the company and its industry, I think that SPWH is an interesting speculative long here around $6.

Reasons to hate it:

• JOBS Act IPO which has floundered
• Retailer in a suffering segment
• Exposure to guns & ammo causing negative SSS, expected to continue
• PE Sponsor share overhang still to be resolved
• Levered balance sheet
• Previous bankruptcy
• Competition from bigger players who are expanding

Reasons for optimism:

• SSS Trends improving last couple of quarters
• Met their Q2 guidance and reiterated full year
• Estimated ~13x current year and 9x forward EPS valuation.
• Early stages of growth, management focused on ROIC

SPWH is a bet on the headwinds facing outdoors/hunting stores abating over the next year.  Management have a decent record since being brought in after the 2009 bankruptcy. There are some levers they are pulling to create value but the core bet is this: This is a company priced for further significant falloff in same store sales, while I believe that SSS trends will stabilize. There are encouraging signs in the most recent Q, but if things just simply don’t get worse, you have a retailer earning a decent ROIC, with significant growth opportunities trading at ~9.5x next year’s earnings. A peer multiple of 14x on next year's EPS gets you to 50% upside.

Sportsman's Warehouse Holdings, Inc. is the #4 outdoor sporting goods retailer, founded in 1986 and headquartered in Midvale, Utah. The stores serve the hunting, camping, shooting and fishing markets. About half of sales are hunting and shooting (guns and ammo about 15% of sales each). As of August 2nd, 2014, the company operated 54 stores in 18 states, primarily in the West.

FY 2013 breakdown:

The stores are typically smaller than comps such as Cabela’s or Bass Pro, with a more limited selection of SKUs. They are also more bare-bones and require a lower up-front investment.  The company often tries to target markets that are too small for the major chains (though there is some overlap).

Get much more background detail from the investor presentation, available at http://investors.sportsmanswarehouse.com/events.cfm

History:

The company was founded in 1986 and expanded rapidly in the 2000s. Too rapidly, as it turned out. Having reached 67 stores, the chain hit problems in the downturn and went bankrupt in 2009. They sold 15 stores, closed 26 others and exited Chapter 11 in August of that year with 26 remaining stores and new management, under the ownership of Seidler Equity Partners (SEP).  Since then, things have improved. The company has improved site selection and merchandising and begun to grow its store base again. In addition to organic growth, SPWH re-acquired 10 of the stores it sold from United Farmers of Alberta in March 2013.  The progress is shown below (culled from prospectus, note the January Fiscal Year):

Of course, their FY 2012/2013 benefit from the surge in gun sales, and FY14/15 have seen the opposite effect. The effect on SSS has been dramatic:

The company has guided to SSS of negative 4-6% in Q3 and 6-8% for FY15, implying the possibility of flat comps in Q4.

Apart from guns and ammo, there has been a second major drag on sales this year: competitive store openings. 6 stores have been affected this year, four more will be by yearend, and five more next year.

The Bear case:

Twin headwinds of increasing competition and declining gun sales will continue.

The Bull case:

Guns/Ammo

The company points to Adjusted NICS data as a guide for recovery in the guns and ammo market. The data has been improving, but the CEO is very clear that they believe there has been hoarding. They also point to a trend in NICS data of overall growth prior to the 2011 surge.  The company provides a chart with historical NICS data:

http://investors.sportsmanswarehouse.com/eventdetail.cfm?EventID=149898

Management shows cautious optimism:

“Although NICS data experiences peaks and valleys, we believe that these peaks and valleys were somewhat exaggerated over the last several quarters. When you look at the data over a longer period of time, it shows an upward sloping trend line or a CAGR of 5.9% from 2005 to 2011 prior to the firearm surge. We look specifically at NICS adjusted background checks which is derived by the National Shooting Sports Foundation. This adjusted data strips out NICS permit checks used by several states, procuring concealed weapon as well as checks on active concealed weapon permit databases among other things.

While not a direct representation of firearm sales, we believe that the adjusted NICS data provides a more accurate picture of current market and demand conditions. Though July’s NICS adjusted background checks remain below year ago levels at minus 4.5%, the pace of the year-over-year declines has moderated since January which saw a minus 45.8% decline. We cannot predict exactly when firearms and ammunition demand will begin to normalize, however we are encouraged by these recent trends.”

For a discussion on what’s going on with sales of guns and ammo, I refer you to the ATK, RGR and CAB threads, which cover the subject in great depth and detail.  I don’t think you have to be too optimistic for SPWH stock to work.

Competition

On competitive openings, there is a sizeable impact in the first year, estimated at 20-30%, but comments on the Q2 call indicate that the affected stores this year appear to be ahead of plan, and in markets where the competitors are mature, the stores comp roughly in line. More importantly, the company maintains that 2/3 of its end markets are served by “Mom-n-Pop” players, and that those are the ultimate share donors. Lastly, the smaller, lower-cost format that SPWH uses means it can target markets where Cabela’s and other larger players probably couldn’t justify a store.

SSS tailwinds:

• Maturing of a young store base: New stores typically comp +10%, +8% and +6% in years 2-4
• Improving the 10 acquired stores, which were performing significantly below the core stores.
• Loyalty program introduced in 2013 driving repeat sales
• New “store-within-a-store” concept for apparel

New store opportunity:

The company has said they see the opportunity for 300 stores and that they expect to grow units at greater than 10% a year for the next several years. New stores may skew to the low end of their 30-50,000 ft2 range, but new fixturing means they can hold almost the same number of SKUs. New store investment runs about $2mm per store, and inventory about $2.4mm. Per the CEO:

“new store underwriting model targets average year one sales of $9.5 million and more and Four Wall adjusted EBITDA margins of over 10%. We target ROIC of greater than 20% including our upfront inventory investment or greater than 50% excluding it”. 

Results for new stores since 2010 have been about double this target, but given the guns surge, that should be discounted. The prospectus and conference calls feature a lot of talk about ROIC, and I’m willing to bet that even with a falloff in gun sales, their low upfront investment means they can at least earn their cost of capital on new store investments.

Leveraging DC Costs:

The company has a single distribution center that it believes can support up to 100 stores, so no new investment should be needed for several years.

Product Mix:

SPWH has begun remodeling stores to expend clothing offerings and have rolled out a “store-within-a-store” model. Private label is less than 2% of sales (a fraction of competitors) but up 25% y/y, and represents a margin opportunity going forward.

Crude Estimates

There’s a lot of moving parts here, but taking a SWAG at how this all nets out for sales:

• Competition will affect 10% of stores a year going forward, that would be 25% * 10% = -2.5%
• 10% unit growth a year, maturing new stores give (10%*10%+8%*10%+6%*10%) = +2.4%
• Guns and ammo comp down 5% in CY 2015 (worse than latest NICS data) on top of the declines in CY 13/14 = 5%*30% = -1.5%
• Apparel, loyalty programs, increased selling space and fixturing contribute 3%  = 3%*70% = +2.1%

I net out to ~0.5% overall SSS. If guns and ammo eventually comp flat, that would mean getting to 2-3% SSS. Fast growing internet sales on top of that (from a tiny base) will help

So for next year (FY 2016) we get maybe a flat comp, average stores of ~60 vs ~52 this year. Allow for smaller footprint (ignoring the fixturing compensation) and you get maybe 10-12% increase in sales (30k/40k) * (60-52) / 52. Taking 670mm for this year (midpoint of guidance) that’s ~$750mm for next year.

I take gross margins at 32.5% (down from the previous year to allow for mix and loyalty impacts), SG&A at 24.5% (~$3.2mm per store basis as increased public company costs and preopening costs offset by leverage) gets EBIT of ~8%. Interest costs come in around $15mm, taxes at 38.5%, ~42.5mm FD shares and you net out to about $0.65 of EPS. 

There are a lot of moving parts and your guess is as good as mine.  Sell-siders are at $0.70, so with the stock at $6.30 we’re at 9-10x next year’s EPS. Could you drive a truck through those assumptions? Absolutely, but it gives a sense of how 60-70c isn’t a crazy stretch.

Valuation:

• Base Case: If the business model holds up as outlined above, I think the company can finance 10%+ growth out of operating cash flows which should drive mid teens EPS growth. Cabela’s trades at 14.5x next year’s EPS estimates on comparable growth rates. That would put SPWH’s value at ~$9-10, for 50% upside.

• Downside If the bear thesis on long term guns and ammo sales is right and NICS falls apart completely the whole space is going to get hit hard. 10% down on guns and ammo would shave another 1.5% off the sales estimate above, which on my Fred Flinstone model above knocks off maybe 5c, so maybe 55-60c for next year. The stock has been as low as $5.50,  ro 10x that estimate, so I’d say that’s probably a near-term floor (also about 11x guidance for this year’s adjusted EPS of ~$0.50). I’m sure the bears can come up with more draconian downside,

• Upside: NICS stabilizes, Apparel initiatives work and the debt is refinanced at lower coupon. The stock gets priced for 20% EPS growth, maybe at 16-18x. That would give a target of $12 off our CY 2015 estimate. Continue to roll out 10 new stores a year and you can get to a $14-$16 present value off estimates a few years out. Aggressive? Maybe, but you’re not paying for it.

Pair trades:

You might choose to pair up CAB or DKS (or even ATK) to try to hedge out some of the guns/ammo risk here, but both shorts have their own idiosyncrasies (eg: CAB – credit cards). See the write-ups on ATK and CAB on why this might/might not be a good idea.

Insiders:

SEP owns over 50% of the stock, John Shaefer the CEO, about 6.5% and the CFO about 1%. There have been a couple of director buys since the IPO, but nothing by officers. I’d expect SEP to sell down its ownership over time.

Risks:

• Gun sales tail off further for longer
• Possible inventory flush by mom-n-pops who overstocked
• Competition from Bass Pro / Gander Mountain / Cabela’s etc.  (mitigant: able to target smaller markets, rational behavior by larger players)
• Increased internet competition (mitigants: 30% of their offerings have regulatory restrictions, their own ecommerce initiative is growing fast off a low base).
• Stock sales by PE sponsor.
• Poor site selection and/or problems w
• ith expansion