Firearms manufacturer Smith & Wesson Holding Corp (SWHC) is facing some tough year-over-year comparisons when it steps into the earnings confessional after the close of trading Thursday. Following a surge in firearm purchases last year, manufacturers have been left with a glut of inventory that is placing pressuring sales. As a result, SWHC stock has shed nearly 19% since the company’s last quarterly report, creating concern for investors.
For the record, Smith & Wesson is expected to post a second-quarter profit of 7 cents per share on Thursday, a figure that is down sharply from earnings of 28 cents per share in the same quarter last year. Revenue is expected to drop 24% to $105.8 million.
Still, SWHC has had little trouble beating Wall Street’s targets. In fact, the company has bested the consensus estimate in each of the past 12 quarters. It should come as no surprise, then, that EarningsWhisper.com reports a second-quarter whisper number of 8 cents per share from the company — a penny better than the consensus.
Despite the inventory concerns, investor sentiment remains bullish for SWHC stock. For instance, data from Thomson/First Call reveals that analysts have doled out six “buy” ratings, compared to one “hold” and one “sell” rating. Additionally, the 12-month consensus price target of $15 represents a whopping premium of nearly 60% to yesterday’s close at $9.40.
In light of the oversaturated firearms market, this optimism is a serious contrarian concern for SWHC’s short-term performance.
Not everyone is enthused about SWHC stock’s prospects. Specifically, short sellers have accumulated a position of more than 11.6 million shares, representing some 22% of SWHC’s total float, or shares available for public trading. In the event of a worse than expected quarterly report, profit taking by this bunch could provide some ballast for SWHC stock.
On the other hand, any potential short-covering rally could be considerably muted judging by recent options activity for SWHC stock. The December/January 2015 put/call open interest ratio arrives at 0.6, indicating that call open interest nearly doubles put open interest among short-term options. Since short sellers often purchase calls as a way to hedge their positions, especially ahead of events such as earnings, it could limit any potential short squeeze situation resulting from a positive earnings reaction.
Click to Enlarge Overall, December option implieds are pricing in a potential post-earnings move of about 15% for SWHC. This places the upper bound at $10.34, while the lower bound lies at $7.66.
A selloff would place SWHC stock at its lowest levels since early 2012, while a rally would lift the shares to within striking distance of resistance at $10.50.
The best course of action for SWHC stock traders is probably to wait and see how tomorrow’s report plays out. Rival Sturm, Ruger & Company (RGR) plunged some 10% in late October following its quarterly report, and SWHC saw a sizable selloff yesterday. As such, much of the inventory concerns and year-over-year sales declines may already be priced into the stock.
That said, any weakness on the guidance front will certainly have a negative impact.
Options Trade on SWHC Stock
Since implied volatility is where options traders make their bread and butter, however, those traders with a stomach for risk might want to consider a Jan 2015 $10 straddle position. Straddles are a great way to take advantage of volatility without having to pick the actual direction of the potential move.
At the close of trading on Tuesday, the Jan. 2015 10 straddle for SWHC stock was asked at $1.26, or $126 per pair of contracts. Breakeven on the upside lies at $11.26, and it’s at $8.74 on the downside. For this trade to hit a double, SWHC would need to trade at or above/below $12.52 or $7.48 when January 2015 options expire — both of which are achievable targets with follow-through buying or selling after tomorrow’s report.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
