Is March NICS Data Responsible For Smith & Wesson's Decline?

A slowing March NICS data led Cowen to downgrade Smith & Wesson Holding Corp SWHC to Market Perform from Outperform. Shares of the gun maker have plunged 19 percent after it also faced downgrades from BB&T Capital and CL King.

"Adjusted NICS background checks rose 9.2% in March with handguns up 16.7% and long guns off 3.4%; but sequential declines of 13.2% and 8.0% for handguns and long guns, respectively, were the weakest of the past decade and well below ten year averages for hand guns (-2.6%) and long guns (+3.6%)," analyst Cai von Rumohr wrote in a note.

"We think it unlikely the data were impacted by lack of inventory at retail from SWHC's low distributor levels at the end of January since February's NICS were strong, especially for handguns ( +25%Y/Y; +7% sequentially)."

"Thus, March data may augur tougher Y/Y NICS compares incoming months, limiting upside to FY17 guide/consensus and disrupting the stock's beat & raise narrative," Rumohr added.

The analyst noted the "current surge may pose greater risk to SWHC than the FY13 cycle since (1) handguns are 80% of firearm sales vs. 64% in FY13 and (2) demand drivers are different."

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"The last surge was mainly driven by long guns/MSR as fears of legislative bans drove demand, while the current period appears focused largely on purchase of handguns for personal protection post recent terrorist attacks in Paris, etc."

"Moreover, November-January's avg. 43% Y/Y growth in handgun checks looks like it may reflect demand "pull forward" triggered by fears of potential recurring terrorist attacks. Indeed, TTM handgun checks peaked in March, and Dec-2015 was the highest month on record, 36% above Jan-13. Thus, there's increased risk if demand continues to falter," the analyst continued.

However, the analyst continues to see upside to the fourth quarter numbers given likely channel restock, planned healthy promos/new product flow, and normal seasonal vigor at the higher margin BTI/accessories division.

Furthermore, Rumohr feels SWHC should enter FY17 with strong competitive momentum and close to $3/share in cash with which to pursue M&A, where it has a strong track record, and stock repurchase.

On the valuation front, the analyst said: "Up26% ytd, the stock looks reasonably priced at 7.7x FY17E EBITDA given strong management with an intelligent strategy and healthy financials; but potential tougher NICS compares in coming months and risk of a downturn in mainstay handgun sales may limit the stock's ability to outperform."

Shares of Smith & Wesson closed Monday's trading down 18 percent at $22.78. Rumohr has a price target of $29.