Description

We may be at the very beginning of a major turnaround in Vista Outdoor (VSTO).   Vista’s revenue has declined YoY each of the past eight quarters, with Outdoor Product segment sales down over 20% and Shooting Sport segment sales down over 30%. Commercial demand for ammunition has declined 20% to 30% during an unprecedented two-year decline in consumer demand for hunting and shooting related products.   Vista’s CEO on the February 7th earnings call said, “it may likely take a few more quarters to begin to show sales growth”.

We think demand for Vista products may be poised for recovery.  January’s adjusted National Instant Criminal Background Check System count (NICS less permit rechecks for concealed weapons) increased 3.4% YoY.   Only one other monthly reading, following Parkland, out of the past 19 months showed an increase. This is an important data point, as Vista’s Shooting Sports segment revenue moves with Adjusted NICS:

Vista designs and sells consumer products through its Outdoor Products and Shooting Sports segments.   Outdoor products include hydration, cooking and optics, with brands such as Bushnell, CamelBak, Camp Chef, Bell, Giro and Blackburn.   Shooting Sports includes pistol, rifle, rimfire and shotshell ammunition, primers, centerfire rifles, rimfire rifles, shotguns and range systems, with brands such as Federal Premium, Savage Arms, CCI, Speer and Stevens.

Vista’s products have faced a large inventory overhang which should be naturally resolved through time.  The massive increase in outdoor goods wholesale inventories associated with a rash of sporting goods store bankruptcies, consolidations and closures is now a two-year old creation which has been whittled down by retail demand.  The massive buildup of ammunition inventories, at both the wholesale and retail levels, while Hillary Clinton was leading in the polls, has also had two years to be worked through. In fact, the political drumbeat for gun control should grow increasingly louder through the next presidential election, fueling renewed stockpiling of ammunition.  Beyond the inventory challenges of the past two years, demographics and Vista’s consumer surveys argue underlying demand for outdoor activities and shooting sports will remain strong. Ammunition pricing has also been an issue, as Vista has had to defend market share. However, the competitor’s reduced prices are not sustainable, as they are loss-making.

Vista continues to possess strong brands, many of which are #1 or #2 in their category. The company’s healthy R&D investment in these brands was not cut as part of the current restructuring program and product launches have enabled market share gains during the current downturn.  Vista’s ammunition is the most frequently purchased and U.S. market share has increased over the past 15 years from 30% to nearly 40%. As an indication of the value of Vista’s brands, the recent $158 million Eyewear sale was valued at book value, 0.8 times revenue and 12 times EBITDA vs. VSTO current valuation of 0.8 times book (5.7 x tangible book), 0.6 times revenue and 9 times EV / F19 guidance adjusted EBITDA of $142 million.

Vista is highly leveraged, but debt is being paid down.   A near-term catalyst is the auctioning of the Savage Arms business, which is made up of centerfire and rimfire rifles and shotguns.   The business was founded in 1895 and continues to win awards. Several new products were recently successfully launched. Because half the business is made to order, inventory overhangs are less of an issue for this business.  There were several competitive bidders for Savage and the sale should be announced this quarter. Sturm Ruger (recently written up on VIC), with $140 million in cash and no debt, is certainly one potential buyer. Savage is carried at a $200 million value and a sell side analyst referenced $35 to $40 million EBITDA associated with Savage, which supports sale proceeds of $200+ million (RGR trades at 9 times EBITDA).    Vista has stated it will pay off $150 million of term loans with proceeds from the sale of Savage, taking leverage below 5x. Vista expects leverage to reach 2 to 3x in the next two years. Inclusive of the $150 million of debt reduction, our projections show Vista below 3x leverage in F21. Vista’s recent debt refinancing increased financial flexibility, lowered interest costs and extended maturities to 2023. The new loans require fixed charge coverage (basically EBITDA less CAPEX / interest) of 1.15 : 1.0 during all quarters beginning with the one ending 3/31/19.   Our projections show Vista comfortably exceeding this minimum, with the ratio increasing from 2x in F20 to 3x in F22.

Margins should improve substantially once revenue increases.   Three quarters into a restructuring plan under a new CEO, SG&A has been cut by a third and COGS have improved.  This past quarter, gross profit, adjusted for the Eyewear sale, grew sequentially despite an 11% decline in revenue.   Gross profit was flat YoY despite revenue down 13%.

There are a few ways to think about valuation and potential for the stock.   The first is based upon the potential for continued margin improvement, which is a focus of the new CEO.   Higher margins seem possible when considering peer and historical Vista margins. VSTO averaged 10% EBIT margins during the 2012-17 period; Vista averaged 11.5% EBIT margins (inclusive of proportionate corporate costs) while part of ATK during 2009-12; peer AOBC’s median EBIT margin from 2002 through today was 9%; peer RGR’s median EBIT margin from 1998 through today was 17%; Olin’s Winchester segment median margin from 1998 through today was 9% (inclusive of proportionate corporate costs).  $192 million of EBIT would be generated at a 9% EBIT margin on Vista’s F19 mid-point revenue guidance of $2.025 billion. Vista currently trades at 6.5 times EV to that “normalized” EBIT. AOBC trades at a multiple of 18 and RGR at 14 times EBIT.  While not perfect peers, these multiples, imply a doubling of Vista’s multiple is possible should EBIT margins improve toward those more typical.

A second way to think about Vista’s upside potential is based upon free cash flow.   Vista is a strong cash flow generator. Vista is guiding to $70 to $100 million in F19 adjusted free cash flow, with $20 million added back for “one time” transaction, restructuring and contingent consideration expenses to reach this free cash flow range.   If one accepts the mid-point of $85 million in adjusted free cash flow and adds $52 million in interest expense guidance to calculate free cash flow to the firm of $137 million divided by $1.26 billion in EV = 10.9% free cash low yield. As asset sales and cash generation enable debt paydown alongside a return to revenue growth, we expect a more appropriate free cash flow yield in the 5% range, offering 100%+ return potential for the stock.

A third way we arrive at 100% return potential is based upon the following projections – which are included in the valuation table below:

• $2.025 billion in revenue for F19; the mid-point of guidance

• Annual revenue growth increasing from 3% to 5% over F20-22.  Last May, Vista expected revenue to grow at a 3% to 4% during the next two to three years.  While the industry downturn has persisted, we believe this growth rate can occur once inventory levels are balanced.  

• EBITDA margins improve to 9% and EBIT margins improve to 5% over time.    For perspective, adjusted for write-offs, EBIT margins, averaged 9% and EBITDA averaged 12% during F12-18.   Vista believes adjusted EBITDA margins can reach 10%.

• F19-22 FCF capture of 70% of EBIT.   Vista has become more efficient which should improve capture from the historic 60+% range.

• Net debt decreases in an amount equal to FCF generation each year.

• VSTO trades at an EV/EBITDA multiple of 9.5, in line with LTM multiples of RGR and AOBC.    Vista will need to demonstrate progress with asset sales, debt paydown and lack of further write-offs to justify peer valuation.   VSTO’s brands support a multiple of 9.5, as outdoor branded peers trade at 10 to 15 times EBITDA.

Catalyst

Catalysts:   announcement of the sale of Savage this quarter and continued FCF generation driving debt paydown.  This alongside a return to revenue growth and better margins justifying higher valuation.