Chit Chat Stocks - Smith & Wesson (Ticker: SWBI) Not So Deep Dive

Episode Date: November 21, 2023

Smith & Wesson Brands, Inc. (SWBI) is a prominent firearms manufacturer, recognized for its iconic brand, but operating in an industry that faces ongoing debates around gun control legislation and regulatory changes. Listen closely as Brett and Ryan go through the history, financials, and future prospects of the company. Enjoy the show! ****************************** Chit Chat Money is presented by Interactive Brokers. Switch to the best brokerage in investing today: ⁠⁠⁠⁠ibkr.com/info⁠⁠⁠⁠ ***************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: ⁠⁠⁠⁠https://chitchatmoney.substack.com/⁠⁠⁠⁠ Want updates on future shows and projects? Follow us on Twitter: ⁠⁠⁠⁠https://twitter.com/chitchatmoney⁠⁠⁠⁠ Contact us: ⁠⁠⁠⁠[e-mail]⁠⁠⁠⁠ Timestamps Company Background | (1:36) Industry | (16:33) Management & Ownership | (21:26) Earnings | (26:41) Balance Sheet | (30:33) Valuation | (32:13) Our Analysis | (33:57) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Anything discussed on Chit Chat Money by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right, welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. My name is Brett Schaefer. I am joined as always by Ryan Henderson. And today, we continue marching along our Sin Stock themed month with Smith & Wesson, one of the leading firearm manufacturers out there want to make a note for any listeners as we continue these sin stocks

we hope as we do on these episodes we separate are that everyone listening separates their personal beliefs about companies whether it's a firearm company like smith and wesson tobacco energy fast food etc etc separate the personal beliefs from the investing that's what we're going to do and focus on today. Although we will mention in this episode that, as people are probably well aware of with a firearm company, legal stuff, regulation comes into play a lot for this business. So we'll be talking about it in that context. But without further ado, Ryan, let's kick things off. Let's talk Smith & Wesson. Smith & Wesson, what do they do? and what is the long history of this company i say as a teaser this is one of the few products used

in before the civil war in the united states and also today so yeah go right ahead yeah it might be the oldest company we've ever looked at i'm not sure when kind of jp morgan was no nintendo was around the turn of the century turn of the century between 1800s and 1900s well next week's going to beat it diageo or however you say that one that can i want to figure that out beforehand some of those brands alcohol is the oldest definitely the oldest of the industries but that's for another time go go get it anyway so smith and wesson the i was i was kind of we've never looked at a firearms manufacturer so i was expecting to be maybe uh like i thought this might be a little more complicated than it really was. The business model is actually

quite straightforward. It's pretty simple. So they're one of the world's largest firearm manufacturers. What that means is basically they've got a number of manufacturing facilities. Really, right now it's basically three manufacturing facilities in Connecticut, Maine, and Massachusetts. And the Massachusetts facility also doubles as their executive offices. However, they're relocating from Massachusetts to Tennessee and at these facilities, they've basically got costly machining equipment that they use to actually create the gun designs. The CEO actually is very straightforward about what their business does. We were talking about this before the show where there's a lot of companies that pretend to be something they're

not. Smith & Wesson is not that type of company. They literally say, we cut metal. That's what we We do. They're a manufacturer. And so that's really what they're doing. They also design the guns. So they do that at their executive offices. They have a number of engineers that are tasked with designing and coming up with new products. And then they build the products through really utilizing subcontractors for their labor, which this has been kind of a transition for their business where they used to have a lot of the fixed costs. It was real employees. Now they've moved to the subcontractors model where it kind of allows them to increase subcontractors when the demand is really strong and then reduce the workforce when demand kind of

fluctuates as we're going to see here and as we've seen over the last year or so. But that's the basics of the business. And then once they finish the production of guns, Smith & Wesson sends their – There's also stuff beyond guns, but they send their finished products to a warehouse in Missouri. And from there, Smith & Wesson delivers them to a variety of customers, including distributors, law enforcement agencies, military agencies, and most importantly, retailers. They've really had a big focus on the big box retailers since kind of the 2006 timeframe. That's the Walmarts, the Cabela's, the Bass Pro Shops, other sporting goods shops, and even kind of the local gun stores. So even though they talk about kind of

professional use where it's police officers, military agencies, that kind of thing, 92% of their sales go to domestic customers. So that's really who they're primarily selling to. But keep in mind, they are selling through the distributors. So they're not selling directly to the end customers, although the end customer demand certainly impacts the demand that they receive from their retail partners. When we talk about the products that they actually sell, there's pretty much three product categories. So there's handguns. This is by far the biggest, And it consists of pistols and kind of to a lesser degree revolvers. So Smith & Wesson is the largest producer of pistols in the United States.

And pistols are the most common gun made and sold in America. They account for anywhere from 40% to 44% of guns produced over the last decade. So they are the largest pistol manufacturer and pistols are the largest source of firearms in the US. It's estimated that Smith & Wesson has about 20% market share in the handgun space overall. Revolvers are much smaller. They don't sell nearly as much in the United States. It used to be kind of the primary gun, but over the years, it's evolved and moved towards pistols. This handgun segment in general accounts for 75% of Smith & Wesson's revenue.

That can fluctuate a little bit, but last year specifically, it accounted for 75%. The second segment here is long guns. This consists entirely of rifles. Rifles are the second most common gun in America, and Smith & Wesson is really the third largest producer here. They're not the primary player here, but they do have a decent share of the market within rifles. And because they've got a lot of those distributor and retail relationships, they can offer some of these guns as well. And they can kind of have a foot in the door to begin with. So it allows them to sell the rifles also. That's about 15% of revenue. Last part, this really isn't that important to the business. It's the other products and services.

This includes firearm parts, suppressors. They sell handcuffs to police agencies, which I don't know. I kind of find that. funny they used to it's just i want to think it's that like tangential to the actual business um but they actually used to be into other things as well it was like handcuffs breathalyzers they used to sell also they basically whatever maybe it's a bundle bundle type of deal for police departments sort of deal yeah and then they also sell like manufacturing services to other businesses so if businesses need to outsource some of the manufacturing they'll let smith

and Wesson do it for them. It's really not a big chunk of the business, but I think the way I think about this part is if you're a customer, if you're a Smith and Wesson customer, say you've got five Smith and Wesson guns, you love the brand, that kind of thing, having those replacement parts available and maybe some of these accessories, it allows them to maintain that customer or that brand loyalty with the customer. So that only accounts for 10% of revenue, but I think it's just kind of additive to the ecosystem if you want to call it that let's talk about the history though before we get to history we're i was maybe pleasantly surprised to see that they were in the handgun market because i think the long from a as well as people are well aware of the

longer gun more semi-automatic stuff is a lot is much more up for you know regulation and stuff like that the united states i thought it was nice that they had a majority of handguns that are not you know like revolvers and pistols and stuff like that that are more for personal protection and it looks like it's a way to the industry here a little bit more broke yeah and i think it's also more of like they sell a lot of classics so a lot of like collectors type of items, which that just seems like it would be less susceptible to regulation or regulatory intervention kind of there. So yeah, I definitely prefer that.

I was glad to see the same thing. But when we talk about the history, I want to go through this because sometimes I kind of gloss over the history for businesses, but I think with Smith & Wesson, it's actually kind of important to look at. So their roots date all the way back to 1852 when Horace Smith and Daniel Wesson formed their first partnership. It was a little bit hard collecting data on this just because it was so long ago, but it's still fascinating to study. Wesson had sort of learned the firearm manufacturing trade as an apprentice under his brother, and him and Smith were working on developing this new style rifle called the Volcanic Rifle. I'm not entirely sure why things didn't work out, but basically three years into their partnership, sales were really lackluster. So they sold the business to a man named Oliver Winchester. For context, Winchester is still a very popular style or brand of a gun. I believe it's a rifle brand.

Anyways, they sold that business and a year later, there was a revolver patent. One guy, I can't remember his name, something cult had a patent on the revolver and it was set to expire. So Smith and Wesson, the people, formed their partnership again, formed a second partnership, and basically started developing for a new style revolver. And they brought in another guy who had a patent that they needed, and it was kind of this interesting business play that they ended up implementing, but that's not really that important. And what's important here is that they had kind of a unique revolver ready to go, ready to ship, ready to sell by the time the Civil War was really going. And the Civil War gave them tons of demand because a lot of the soldiers wanted a revolver just for private use. They felt less safe, which kind of makes sense during the Civil War.

And so this really, this is when they started to see a surge in sales and it gave them the funding to continue to innovate and try to build new guns and give them a little bit of runway and kind of become a real business. So they found success with a bunch of different models over the basically following 100 years after the Civil War. They started to kind of build those relationships with military agencies, the new frontier. A lot of people wanted certain handguns. They wanted revolvers. You probably see that in a lot of the old Wild West movies, guys with revolvers. That probably helped with marketing on revolvers and stuff like that. But really, it was just a pretty simple model. Build new guns, establish more relationships with

distributors, sell more guns. And every post-war era, they started to see a surge in demand, but it's always been cyclical. It's still cyclical. And they experienced that pretty pretty much all throughout. It wasn't until, I guess, 1965 is when things, I think, started to change. So the Wesson family sold their stake in the business to an American conglomerate called Bangor Punta. And from that period forward, the business kind of exchanged hands a number of times. And I don't think all of this history is relevant, but something happened in 2000 that I think is actually important. So in 2000, Smith and Wesson made an agreement with the US president at the time, Bill Clinton, that really limited what gun manufacturers were able to do. It was

meant to be this kind of gun smarts program. And it basically said, there's a whole bunch of different stuff that's in the program. I recommend looking at it, but they said you had to have safety locking devices. You weren't able to sell to anyone. No, you weren't allowed to have anyone under the age of 18 in the stores. You had to have, I've got a list here of different kinds of things. It says new firearms are not able to accept ammunition magazines with a capacity of over 10 rounds. There was one where it's like, yeah, it's 2% of annual firearms revenue will be dedicated to the development of authorized user technology that can limit a gun's use to its proper owner. Basically, all these programs really hampered a lot of, I guess, gun sales.

and Smith & Wesson saw major boycotts pretty much started by the NRA saying that Smith & Wesson's trying to collude and basically hurt other gun manufacturers. And so they saw these massive boycotts. The CEO that helped create this deal was removed. Smith & Wesson was sold for $15 million. The stock traded down to 19 cents a share. It was sold by Tompkins PLC. They had acquired them two decades earlier for $112 million, and they're selling them for 15 million. So when you look back and you look at the stock return since the year 2000, you'll see it's a 100 bagger. It's worth remembering that it was sold for $100 million in the 80s, and now it's only a $600 million market cap. So the returns have not been that

great, but they look really good if you look at it from the turn of the century on just because of where they were at. So the returns, stock returns are a little misleading, just worth noting that. Last thing I'll say here is around 2020, they divested their outdoor products business, which sold a lot of hunting gear, gadgets, stuff like that. I don't think there were really that many synergies between the two businesses. That business was not very profitable. It was a serial acquirer. It was all basically inorganic revenue growth. And it's still a stock.

You can look at it. Look at his market cap kind of deal for the returns. And it's called American Outdoor Brands. So there's just a split. Now there's a... I forget the ticker, but if you look up American Outdoor Brands, you can find that one. Look at that business. See the size of it.

And as we head into on the newsletter, which we would see, I've separated out kind of the firearms, say, when they had this. So we can see kind of pure Smith & Wesson revenue and operating earnings, just as if that business wasn't there. I think that's basically it for the history. I mean, the last, it's a little hard to like get a gauge on like a decade's worth of like earnings because they've had that divestiture. But really, I would say the operating cash flow, if you look at Smith & Wesson over the last 10 years, really 2012 to 2022, that was mostly the Smith & Wesson business, like the firearms business, the outdoor products, it wasn't very profitable. So I guess I'll leave it there. You want to talk about the industry and the landscape overall?

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Member SIPC. Open an account with IBKR today. Yeah, as you said, this is a cyclical industry. It's a bit unpredictable. It's one that has many different what you'd call maybe cultural macroeconomic factors that can be in play here here is a direct quote from their proxy statement historically the firearm industry has been very cyclical with past expansions and contractions driven in large part by unpredictable political economic social legislative and regulatory factors beyond the control of industry participants and their management teams so you got the five you have political economic social legislative and regulatory that could all affect things here um i think people should take that into account that's

what happened as we'll talk about during the pandemic it's what happened in what happened when there's different political parties coming into power in the united states which for any internationalists i know it's about 40 of us 40 of you out there when one of the parties has a more as a reputation for being more gun friendly and the other one has a reputation for being not gun friendly so when one of those is in people panic and think that they're going to have to buy some or maybe not panic but there's more of an incentive to buy one before you know they think that reputation comes into uh laws um but to get you on with the industry as ryan mentioned there is really one thing that matters for smith and wesson and that is that they operate a virtual

duopoly in handguns which are the pistols and revolvers which is their main segment their main revenue driver i'm assuming their main profit driver if we look at a table i pulled from a value investor club write-up that i will link to i believe it was the one from 2022 so fairly recent uh smith and weston and sturm ruger both dominate this market with total volume for pistols and revolver or pistols at over a million well there's not really any other sizeable competitors there is Glock and a few others but yeah so the handgun market is the one that's going to be the most important for this company to follow and if you look at gun sales in a chart that I will include in the newsletter they have generally gone up in the United States

since the great financial crisis but not too much I mean there was a surge kind of post the deflationary period in kind of 09-10 and then it was stable maybe up a little bit you could argue It was only a few years, but then during the pandemic, unsurprisingly, you will notice there is a big jump and now we're coming back down. So the question I have for you, Ryan, and I'll try to answer too, as investors, I think the most important thing to do is ask, can you predict or have confidence in predicting handgun sales in the United States? And can you predict or how confident are you predicting whether Smith & Wesson will be

able to retain its market share its brand value i think the second one i'm fairly confident smith and wesson given its decades-long history of being a leader in the handgun market will retain its brand retain its market share but the first one that's the kind of the first concern i had when looking at this company yeah i mean it's definitely hard to predict on uh any year over year basis i mean you're looking at who would have thought going into 2020 that you would sell whatever twice as many pistols as the year before it's it's really hard to predict it's it's based on really a lot of like social movements uh yeah i think i think they even talked about this where it's like it's very fear-based when people are worried about something happening

that there's more gun purchases um so yeah demand i think is really hard to predict regulation will certainly play a part and has played a part in given years although i kind of mentioned that the brand is solid when i look back at 2000 and we've kind of seen this with the bud light too if they do something wrong or if they do something to piss off their customer base like it can almost kill them i mean it almost destroyed them in in 2000 and so um it's like the video game market as well people like you can ruin your reputation pretty quickly with your core customer base i will say if you listen to the management they are always optimistic about future industry trends and they love pulling data because you can make these charts these

gun sale charts really tell whatever story you want um they talk about i believe on this last comments call a normalization uh reversion to upward hire and i'm like i don't know how confident you guys should be here who knows if the code was a permanent jump or a little bit of anomaly but let's talk about management and ownership ceo is mark smith 47 years old a little young which is kind of interesting um he's been a ceo since 2020 has been with the company since 2010 he's essentially been in a leadership position at the smith and wesson division since 2016 so somewhat long tenure uh done the company's done fairly well under his tenure management made the tough perhaps force perhaps maybe just a bold there was a lot of factors i probably played it

here decision to move its manufacturing out of massachusetts tennessee unfortunately for them massachusetts uh has enacted or has been close to enacting some of the strictest gun laws in the country they're one of the strictest out there they have one of the lowest gun ownership rates. It probably wasn't even the best place for them to have their headquarters and their manufacturing. And they were going to do a law, or they maybe passed it, banning manufacturing, which would really hamstring Smith & Wesson. So the movement of Tennessee, it's like- It might've been the best spot when Smith & Wesson was formed. Right. Which a long, long time ago.

This is the war. Yes. Yeah, exactly. Exactly. Here's a quote from the press release on that, We'll talk about later the impact and how expensive this has been. So for a company this size, it has been expensive. Here's the quote. Total investment in the project is estimated at $120 million and will be funded with cash on hand and is expected to be accretive to earnings per share of about $0.10 to $0.12 per year once fully operational.

So they think it's really going to help once this thing gets built up. But CapEx has been elevated there, as Brian will probably talk about during the earnings. Frankly, though, if I look at executive compensation and the nitty gritty of the proxy statements, it's one of the most disappointing I've seen. Here is a list of what stood out to me. One, performance stock units are delivered based on relative performance to the Russell 2000 index. So one, relative performance, and two, it's the Russell 2000. I think that's self-explanatory. Second, bonus payments are based on adjusted EBITDAs, which has an S at the end.

Don't know what the S stands for, but just think about it as adjusted EBITDA and net sales targets. It's stock-based compensation, but the... That's the adjusted EBITDA. I don't know why that's not just... You could just call it EBITDAs in that case because that's supposed to be the adjustment, but yeah. Yeah. If you control F, the proxy statement, there's not one mention of per share in the proxy statement. And if I'm looking at an anti-ESG business similar to it, BACO stuff that's going to have flows moving against it, potentially, I want them to take advantage of that.

It doesn't seem like they're thinking about it too much, although I will mention they have done some buybacks. It hasn't been crazy good. And then I have a screenshot for the newsletter. are i'm obviously here fully but the adjustments that are made uh after EBITDA which is already adjusted are quite telling first let me just read the first one it says accelerated expenses related to the refinance of our credit facility like okay they're adjusting that up so basically a lot of things there's something in here but they're recruiting i mean this is a large paragraph would take me two minutes to read they are adjusting a lot out of their earnings and

And they're paying themselves on that. So that is just a huge concern for me and I'm guessing for Ryan as well. What do you think about the proxy and management, Ryan, before we move to Erics? Yeah, I mean, that's a major bummer. I'd have to look at how much they're getting actually paid, like the actual dollar value, because this wouldn't completely keep me out of it. unless it was like a huge sum or a big chunk of the cash flow the good thing is they don't have a lot of executives so at least from from what i saw so it's not like they're paying a bunch of different people based on these it's pretty much mark smith and two or three others

right it's not salesforce but i think they had four maybe yeah the uh i mean yeah it's not sales force but the thing is like sales force makes so much money that it it's honest like it's less concern i i don't know neither of them are the best situations from in our opinion from a proxy statement but let's earn earnings it's earnings excluding expenses basically yeah they've tried to smooth they've tried to take a cyclical business and made their and make their compensation smooth and in order to do that they've they've taken it as earnings minus all expenses so it reminds me of uh the guy on twitter uh not account willis cap that says i have a great i think i can provide a lot of value to these companies you are adjusting your ebitda let me join your company and

just adjust it further because we can adjust it to wherever we want it's adjusted it's all made up Yeah, that is true. All right. Well, yeah, it's a bummer. It's kind of disappointing, but let's go to the earnings. For context, in 2020, they generated just over a billion dollars in revenue, 2020, 2021, that timeframe. Their fiscal year is a little weird. Over the last 12 months, they've generated $509 million in revenue. So you can kind of see the cyclicality there. Gross margins around that time, if I'm not mistaken, were almost 50% in 2020. And today, over the last 12 months, they've been about 33%. The kind of target 32 has actually come down even further. But there was, I believe, some kind of one-time accounting things that went on there. Fiscal year 2021, which most of – a little bit 2020, a little bit 2021, 30% operating margin.

Yeah. I mean, they're over-earned and management even knew it. I think analysts knew it, management knew it, pretty much everyone was clued in that they were over-earning. Over the last 12 months though, they've generated $50 million in operating cashflow. That is low, that is quite low. And I'll talk about what they've earned over kind of a decade's worth, but what's happening right now, I think is basically what I should try to get to here. So sales have obviously slowed significantly following 2020. I think the political climate has kind of calmed down. I think people could probably say that with a lot of certainty relative to 2020. That has probably contributed the economic hardships or kind of inflation and

budgets getting or consumer spending, especially on discretionary items coming down. That's probably hurt them also. And then inventories have also been built up. Not to mention, they're also relocating their main facility, which has been really costly. So they've gone from generating $120 million in annual operating cashflow. That's been the average between 2012 and 2022. That was the average amount of operating cashflow. So 120 million. And they were spending on average about $30 million in CapEx over those 10 years as well. Now they're generating just $50 million in operating cashflow. So less than half of what they've done on average. And they're spending more than $100 million in CapEx. So they are

now burning cash. This last quarter, it was a slight improvement. They were free cashflow positive. And as they kind of complete the relocation, CapEx, a lot of that CapEx should start to roll off. But for the time being, cashflow looks quite depressed. Let's move to the balance sheet though. I guess maybe one takeaway from the earnings is that if you're a believer here, if you're an investor, I think you have to believe that they get back to kind of what they were earning on average over the last decade, which is more than $100 million in operating cashflow and roughly $100 million in free cashflow. It's probably achievable, but in the short term, they're certainly going to have some headwinds with the CapEx related

to relocation. Any thoughts there? Yeah, you said the discretionary stuff with inflation, any sort of pinch pocketbooks. An important thing that I probably forgot to put in the industry part is that Gun ownership is concentrated under a small percentage of the population. Well, not that small, but the average gun owner owns multiple, like five or six. It might have been nine. So it's not like the one person that's going, oh, I need one of these. That's not their core customer.

It's, all right, do you want that next one? You know, it's more of a, as Ryan mentioned, discretionary item. So as pocket goods are pinched, some people might be like, yeah, I already got one. Do I need this next one? that can be a big factor for their earnings. Yeah. I think I saw numbers of a third of the population owns a gun, but the people that do own guns own nine on average, which I think is the number you mentioned. But let's go to the balance sheet. I thought this was not a lot here that was that useful to look at. They have $55 million in cash, say, on the balance sheet,

$170 million in inventory. That has started to come down quarter over quarter, but it's really started to build up over the last year and following the basically over-earning or the surge in sales that they saw in 2020, they invested into that and inventory has been built up because of it. On the liability side though, basically 25 million in notes and loans payable. This is part of a revolving credit line that they have with a number of banks. They can borrow up to 100 million. They're really only borrowing 25 right now. The interest rate is slightly high at 6.8%, but it's really not. It's kind of inconsequential. They've got finance leases, but so does pretty much every business. I thought the balance sheet

is fine. I like that they've pretty much not used a debt in their history, or at least in their recent history, given the cyclicality. Because I think if they were levered up going into this year, they'd be in a very different position. However, they did say at their 2021 investor day that they don't they were like we never want to go below 100 million dollars in cash and well two years later we're below 100 million dollars in cash so it's a little frustrating it's not like it's not like they spent it all on buybacks they've spent it predominantly on relocation yeah and they uh like not many companies are forced to do that let's just say right it's because of the uh political stuff and the legislative stuff all right valuation

going to be a simple one i think i'm going to try to normalize kind of the operating income and stuff like that so if you look at their let me just list out the revenue from 2018 fiscal year 2018 to 2023 449 million 478 million 526 million over a million 864 million and then 2023 479 million come back to that 2018 2019 range now we've had high inflation so i think we can bet that if it normalizes back to 2018 2019 unit levels uh which should say fiscal year 2023 had much lower unit levels in 2018 and 2019 for the handgun unit segment we should get higher revenue so uh my estimate is kind of for normal you know on average it's This would be kind of averaged throughout the cycle, maybe $600 million in revenue.

And then if we look at pre-pandemic operating margin, one year it was 6.7%. Some years it was above 10%. So I kind of went with a 10% operating margin. I think that's fair. Maybe a little conservative. Could they hit 15%? Wouldn't be surprised. But I will have a note on our conference call that kind of makes me lean towards that 10% range.

So that's $60 million in earnings. We look at their market cap. That brings us to a price to operating income of about 10.8. So not too cheap, but definitely cheaper than the market average, if you believe that. And remember, this is pre-tax and stuff like that. And in a best case scenario, if they're earning $100 million in free cash flow, then it does look really cheap. But I like that you're using- You need that margin expansion.

You need that margin expansion. All right. anecdotal evidence i know for a fact we both are not i guess we don't have to discuss but uh we don't we're not going to gun shows and stuff like that so i don't think i have much maybe not the core customer uh i guess anecdotal evidence on kind of the business and the brand it seems like they're here to stay it feels like they've certainly moved past the hiccup that they had in 2000 i would think that they have had they have pricing power they've been able to increase their average selling prices over the years but the one people with inflation yeah

they've tried to like remedy the cyclicality that they've had over the years so that they moved to this flexible structure this or flexible like labor structure with the subcontractors um they i'm trying to think of the other things they've done but it it doesn't feel like it really has made that much of a difference i guess and they i don't know i mean yes they're probably the best brand but they're in the mix there with some of these other ones and i don't know if they separated themselves as a premium brand which is what i would like to see i would be much more attractive if they were like the definitive apple express type thing yeah i mean i do think they're seen as like quality but not good yeah it's good yeah yeah

it's not a luxury gun brand i don't know if there is a luxury gun brand but um yeah and it's a balance because your core customer you know i don't know it might not care about some of that type of stuff you know the hunting style the more rural areas and stuff like that i do like okay i like that they spun off the outdoor goods business i didn't like that i appreciate that they're they know what they are and they lean into it i i think the brand is valued by the customers but i i just have no sense of where demand is heading that's my only concern yeah this is this is my note like that the uncertainty here is crazy like if someone told me five years from now uh firearm sales were the same i'd be like okay

not surprised if someone said they were doubled from last year i'd be like okay i guess you could make an argument but if someone said they were cut in half i'd be like yeah that also could make sense i don't know right yeah this kind of leads us to these future growth opportunities which i didn't come up with anything because they're hamstrung by maybe i'll just go can they go international no no other country really cares about this can they go direct to consumer no they're not going to really want to do that given the industry dynamics can they go online no probably not i'm guessing no if you can buy guns online i would be concerned uh i don't think they can't market to the end consumer really like they i mean they can't like

i don't think they could run tv ads yeah maybe actually i don't know i don't think i've never seen like a gun at the super bowl yeah well maybe not the super bowl i think maybe local ads i don't know i struggle to find ways i think in general for them to be proactive to spur customer demand and but curious what any of your thoughts here no i mean future growth opportunities they've been doing pretty much the same thing for 160 years so i think the formula is pretty simple here launch a couple new products every year make sure that you maintain a good relationship with your customer really lean into that and they do a pretty good job of that they even sell like merchandise like clothing for their their avid customer uh i my big hope here

is that they try to earn as much as they can despite the cyclicality and they don't do anything stupid with it. Like don't make any acquisitions. And there was a question posed at the Investor Day, I think in 2021, where they were like, would you ever do any acquisitions?

Like we're never going to say never, but that's not a priority for us. And I appreciate that. So hopefully they continue to just do what they're doing. Yeah. And maybe I'll say the buyback, importance of the potential buyback for later for an amp at esg company but let's go highlights and lowlights ryan what you'd like what you dislike about this thing well i like i like that it's a strong brand i like that they have so much history and and you know that they've been around

for a long time they also seem to have a pretty there seems to be a lot of affinity for smith and wesson from like gun gun owners it looks like that also i kind of like the fact that the inventory buildup isn't the biggest deal for them. I know you're going to talk about average selling prices being slightly lower, but they've done this before where they had big inventory buildups and depreciation hasn't really changed that much because they're going to sell these things eventually. They just have to reduce their production and let the basically older guns sell through. So I like that. And the CFO, even at the investor, basically said, inventory isn't that bad for us. It's not like other manufacturers, which is certainly a positive.

It's still going to be cyclical, but it means cashflow is not going to be quite as hurt during down periods. The other thing is the new headquarters should reduce travel or days in transit for the inventory. So they shouldn't be holding the inventory quite as much. Tennessee is closer to Missouri. They're going to be able to get the guns to the warehouse a little quicker. and I think it's close to a lot of the end customers as well. So, I mean, that's a positive. If you just take the current headquarters and you move it down to Tennessee,

assuming that the CapEx doesn't change from kind of the last 10 years and you get sort of a similar level of CapEx, they're going to be in a good spot. Lowlights for me though, first of all, they could maybe have more CapEx than they're currently forecasting. that would be kind of a big one. The other part is they said a couple of things at their investor

date that this was in 2020. And this was when they're like, if you listen to the conference call, they're like, yeah, we knew it wasn't going to happen. We knew 2020 couldn't keep going, but they over, or I think they underestimated how difficult the cycle could be because here's a quote. An analyst said, I think what I'm hearing is that you guys could do 20% EBITDA margins, even with revenue in the mid 400 range. And keep in mind, this is when they were doing a billion dollars in revenue. Is that what you guys are saying here? And Mark Smith said, absolutely, period. Yes. Well, they're in that range on revenue and margins are at 15%. So they haven't, the flexible cost structure hasn't really had the impact that I

guess they thought it would. The other part here, they said they wouldn't dip below a hundred million of cash ever they have then the last one i'll say is the political and regulatory risk i'm it's not like some people i think they hear political risk and they think guns will be forever that's not really my concern my concern is more that it might get harder to buy a gun which this is not as we should be clear we're talking from an investing perspective yeah and then the other one is like state by state you saw they had to move their headquarters out of Massachusetts. These are something that other businesses don't have to deal with as much. Maybe tobacco might have to deal with it to some extent, but that's been really costly

for them. And it's a lot of it has to do with the business climate in Massachusetts. So it's just, I mean, it continues to be something that's difficult for them to navigate. Yep. All right. My highlights, longstanding brand, I think fairly confident it'll be around in 2050. why wouldn't it be but again we talked about the concerns over the industry how big will the industry be tbd i will highlight something on the or excuse me low lights let me highlight something uh on the political risk unlike tobacco like i could see regulation get materially worse for smith and wesson because it seems like tobacco the at least generally at the edges are many things but the worst is kind of open and this company showed there's no signs of building if

we're going to use the tobacco analogy risk reduced products they don't own axon it'd be like the tobacco is like if they owned axon and smith and west i think this presents presents a much bigger risk than the tobacco stocks in my eyes second management has bad incentives i would remind listeners of that third industry is unpredictable we talked about that uh population tailwind may be running out maybe because rates of ownership have been in a relative band around 40 maybe a third maybe a little higher than 40 since the 70s and it's kind of swung around a tiny bit but it hasn't been like a secular percentage of people in the united states that are owning guns but over that time the number of people in the united states has been growing at

consistent rate, and that's projected to slow down significantly. I think that's something to consider for a long-term shareholder. And what you're really making a bet on is, will the average gun owner own 12 guns in 2027 versus nine today? What evidence is there that that will happen? I think that's concerning for me. Here's also a quote from the Congress called that concerned me, quote, we will likely use promotional dollars to drive some of that volume, and therefore, We anticipate a 5% to 10% drop in average selling prices versus what we saw in our first quarter. This is the last conference call. They're price takers, not price makers.

That shows me the brand is not as high of quality as some other consumer products out there. Yeah. It's just kind of a tough business because I look at this and I just kind of think it's nothing self-inflicted other than that deal that they did in 2000, but they're hurting today because of everything pretty much outside their... A bunch of factors outside of their control. Let's go to the bull case though. I'll talk about mine. It seems like there's a very realistic scenario where this ends up being a good investment. So the CapEx or all the costs related to the relocation starts to roll off, starts to trickle away, and they get back to

of that 30 million dollars on average capex demand bounces back to where it was i think we're kind of at a uh it's hard to say well it's hard to say but it feels like we're lapping covid and a lot of people bought guns in the last two years that just have taken a step back i would imagine it doesn't need to get that much higher the revenue does not need to get that much higher in order to see a little bit of margin expansion and like the numbers work pretty well you could see quite a bit of operating earnings growth if you get into that close to 700 million dollars in revenue each year as long as units are fairly stable like they're not falling off the cliff yeah no or actually if they were never like as long as they're not pushing like a ton at no margin

the opposite way yeah i mean maybe they have another scenario like 2020 where maybe it's around an election, something really bad happens, or I don't know, and everyone feels incentivized to go buy a gun, that helps them. And hopefully they don't have to spend all that cash on a relocation again. The other part is I do like the idea of the flexible structure. I don't think it's played out quite the way they were hoping, but in general, I think that's certainly a better way to alleviate some of the cyclical issues. And then they should be able to operate a little leaner on the inventory side, seeing as their manufacturing facility will be closer to the warehouse. It won't be that big of a difference, but it'll be a slight help.

So if all that kind of happens, basically, I think that's essentially saying that sales rebound and the relocation goes as planned, I think there's a very realistic chance that they generate the same kind of cash flow that they did over the last 10, over the next 10. And if that happens, they would be generating roughly twice their market cap in cash over next 10 years, which assuming that they are smart with that cash, hopefully they buy back stock, and you do get like a 3% dividend right now, and that's gone up over time, I think you're getting 15% plus returns in that case easily. Yeah. Ryan's scenario is similar to what I think the bull case could be. Your earning

ratio is going to be well below 10. If they plow a lot of money into the buybacks and they have no flows from a lot of the restrictions of people buying this thing, yeah, things could work out quite well bear case look i think it's kind of the opposite of this the forward earning like the margins don't expand i think it's the key thing and it's not a bullwhip it's more of hey like demand for guns is actually kind of down significantly um even from pre-pandemic anything else you want to add there right before we go to the final thoughts i just kind of think that like with the with the when you look at the regulatory risk it feels like a risk and i don't think there's a situation where regulation helps them a lot like like if regulations loosen a

little bit i don't see like yeah gun ownership going up by that much i think at this point like if you want to own a gun you can go on a gun and and gun ownership rate seems like where it would be in in any sort of lenient environment and i only kind of seen it i can only kind of see it potentially hurting them which it's just yeah it's a tough risk to quantify um but i guess more or less interested yeah i i'm probably not gonna buy this it feels a little too cyclical for me if it got really really cheap maybe yeah uh i know punch card capital who i kind of checked their 13f every quarter because they only own like four stocks norbert lou he's pretty like i think famous stock picker he owns them it's a really small position but i don't know if you

really like his style maybe this is something that that's worth looking at a little deeper Yeah, I'm less interested. I think they are a price taker, not a price maker. I think they're in a cyclical industry. I think they're in a risky industry from a legal political perspective. They don't trade at a dirt cheap valuation. Why would I buy this over a 9% dividend yielding tobacco stock? I don't know. and we can compare that as a little tease as we do the end of the month we're going to do a little discussion maybe a little debate try to mix it up here as we kind of move past doing these arch capital episodes where i'm going to do a pitch on altria group and we'll say on that it might be a pitch of like okay this is where i'm looking to buy i haven't really figured it out yet i don't own it um and then ryan will try to do some pushback there as we go through the end but as we close things out next week before that that all true one's going to be two weeks from now next

week, the most exciting one, or this is the one I'm most excited for. And it's the one I can't pronounce, Diageo, whatever you say, the liquor brands, Johnny Walker, Guinness, I believe, Casamigos, a lot of other ones. We're going to figure it out. And they're in kind of a pinch right now. Stock's down quite a bit, so should be a fun one. As a disclosure, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners that are well, not anymore. We may own securities discussed in this podcast, either Ryan or I, and you may buy or sell them in the future. So thank you all for listening.

Hopefully you continue listening to our not so deep dives and we'll see you next week. You