Sportsman’s Warehouse: Waiting For A Margin Of Safety (NASDAQ:SPWH)

Sportsman’s Warehouse Holdings (SPWH) extended its good performance from Q1 into Q2, with tailwinds looking to continue for its second half.

The company is benefiting from the decision made by other retailers to limit or completely stop the sale of firearms and ammunition while demand for such products has been increasing since the pandemic broke out. Additionally, growing political and social unrest has been increasing the demand for firearms. Management made comments about market share gains in these categories during Q2.

The pandemic also shifted discretionary spending from travel and entertainment towards outdoor activities. The company cited data from the Colorado Parks and Wildlife department showing an increase of 90,000 more fishing licenses issued compared to last year.

We believe these tailwinds are going to persist for the foreseeable future. The surge in demand for firearms highlights the concerns of many individuals about their safety. With a country divided and social unrest increasing, we see don’t see a slowdown in the purchases of firearms.

With a vaccine for COVID-19 still in development, we believe consumers are still looking at outdoor activities as the best way to spend time with the family or some quality “me” time. We believe SPWH is well-positioned to fill that demand, while creating an opportunity to grow its store footprint. The company has recently opened a new small-format store at roughly 7,500 square feet, which management believes is ideal to penetrate small to mid-sized markets, where competitors might have trouble performing due to their average store size, making it uneconomical to target such markets.

There is good momentum behind the stock with shares trading close to their 5-year highs after an impressive surge.

From a valuation point of view, the company is trading at a forward P/E multiple of 13x. SPWH is trading in line with its peer group.

While we like how SPWH is performing, we believe the recent volatility in the markets might give us a better entry point and a bigger margin of safety. We are keeping this stock in our watchlist, as it might be a good addition to our portfolio.

Blowout second-quarter results

SPWH reported second-quarter sales of $381 million, up 79.9% on a year-over-year basis and beating expectations by $100 million. The company non-GAAP EPS of $0.76, beating the consensus by $0.47. Same-store sales increased by 61% compared to the previous year.

The impressive results were driven by huge demand across all of their major categories, with significant increases in firearms (with same-store sales up 123%), ammunition (up 75%), fishing (up 45%), camping (up 46%), footwear (up 30%) and apparel (up 19%).

The company’s young e-commerce channel (launched in 2018) also performed exceptionally strongly, showing growth of over 300% versus the prior year, and now accounting for more than 10% of total sales through the first half of the year.

SPWH also accelerated the roll-out of value-added service such as “buy online pick-up in-store,” which would expand the product catalog offered to customers (40,000 SKUs in a single store vs. 138,000 SKUs company-wide), while increasing the possibility of having incremental sales once the customer enters the store to pick up his purchase. We see BOPIS as an effective way to increase foot traffic.

Also positive during the quarter was the growth in its loyalty program to nearly 2.5M members and increasing the company’s overall e-mail list by 68% compared to the prior year. We believe a strong loyalty program not only increases SPWH’s brand awareness and improves transaction volumes, but improves the data collected from its customers, which can then be used to target personalize products and offers.

SPWH’s strong operating results have also translated to a better balance sheet at the end of Q2. The company reduced net debt by $150 million and improved liquidity by $130 million on a year-over-year basis. SPWH ended the quarter with a net debt-to-EBITDA ratio of less than 0.1x, becoming almost debt-free.

Room to grow

The main growth driver for SPWH comes from expanding its store base. The company is still committed to its goal of increasing its square footage by an average of 4% to 6% per year. SPWH has open an average of 9 stores per year, including some small acquisitions.

Year to date, the company has opened 4 new stores, with plans to open another 3 in this fiscal year. Management is also testing a small new store format at only 7,500 square feet, compared to the average store size of 40,000 square feet. This new store was opened in Laramie, Wyoming in early August, and so far the results look “encouraging”.

The adaptability of SPWH’s stores could act as a growth driver. The idea of a small store concept to target small to medium-size markets is an interesting one, as it would create more opportunities to find adequate real estate locations.

By positioning its stores to be larger in size from many independent retailers but smaller than its national competitors in small to mid-sized markets, SPWH would carve out a nice niche for itself in which a large sporting goods retailer might have trouble turning a profit in a small market due to its size, but have the possibility to gain market share due to the bigger scale it has compared to a local independent retailer, while offering a greater selection of goods. In a way, SPWH would create small barriers to entry in the local area:

We believe our flexible store format will continue to serve as a competitive advantage moving forward.

Source: Q2 call

We also believe the increase in firearm sales could lead to upsell opportunities down the road. During the first 7 months, nearly 5 million people purchased a firearm for the first time. Management believes the company gained market share in this category:

Total Sportsman’s Warehouse firearm unit sales increased 100% and 71% during the quarter, while the adjusted NICS checks were up 111%. Our unit sales materially exceeded the NICS checks increase for the quarter, which confirms that we are continuing to gain market share and new customers.

– Q2 call

Management notes that a firearm customer has the highest lifetime value of any segment within the company’s customer base and drives value across other product categories in its business. For example, a first-time buyer could easily find themselves purchasing another type of firearm once they gain more experience, not counting the accessories and maintenance products needed.

While it’s almost impossible to predict the changes in consumer behavior, we believe the tailwinds enjoyed by SPWH from other categories such as fishing and camping could have lasting effects. For example, people new to fishing might take the hobby as a permanent activity, while families might find camping as a nice way to spend quality time, leading to opportunities to generate incremental sales.

Bottom Line

Trading at a forward P/E of 13x, in line with its peer group, we believe SPWH is being fairly priced.

We believe the company has room to grow and the balance sheet to do so. However, given the unpredictability of the current environment, a bigger margin of safety is preferable.

That said, with the recent market volatility, we might find ourselves not waiting too long before a better entry point is presented. Therefore, we are keeping SPWH on our watchlist.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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