Vista Outdoor: Favored By Industry Consolidation And Demand Post Spin Off (NYSE:VSTO)

Vista Outdoor, Inc (NYSE:VSTO) is trading 54.56% below its 52-week high of $52.69. It came out of Q2 2023 earnings with an EPS of $1.71 beating estimates by $0.01 but dropped 29% (YoY). The company posted revenues of $781.68 million gaining 0.41% (YoY). It expects its annual revenues to surge over 50% in FY 2023 as compared to the pandemic-ridden FY 2020. The growth will be boosted by the expansion of its brand portfolio and new product innovation that will steer organic growth.

Thesis

VSTO intends to spin off its outdoor product line from its sporting section to form two separate companies that will enhance resource allocation and drive overall growth. The company has decided to pause its merger & acquisitions and focus on paying down debt. In the long run, it aims to concentrate capital on solid investments that will have a solid return to shareholders.

VSTO’s total revenues declined 2.6% (QoQ) to $781.7 million as its costs of revenues increased 7.6% (YoY). The decrease in sales was due to diminished levels of finished goods in the quarter. The decline was, however, offset by the company’s favorable pricing. Higher costs of inputs also pressured gains. Net income also declined 25.79% (QoQ) to $93.5 million and its gross profit decreased 11% (YoY) to $265.9 million.

The first half of the company’s FY2023 has seen free cash flow increase 84% to $195 million after it closed its acquisitions of Premium Outdoor Lifestyle Brands and Simms Fishing. What caught my attention, however, is that out of the $782 million in sales recorded in the quarter, $432 million was from Sporting Products while $349 million was recorded from sales of Outdoor Products. VSTO has 7 Sporting Products brands against 34 Outdoor Products brands.

The spin-Off is a good idea

In FY 2022, VSTO’s Sporting Products which mainly includes the sale of ammunition posted $1.7 billion in sales against $1.3 billion from Outdoor Products. The company’s spin-off of the outdoor segment is expected to increase VSTO’s strategic focus as well as tailor its capital allocation priorities as required. Revenue in the trailing 12-month period stood at $1.9 billion for Sporting Products while Outdoor Products hit $1.3 billion (TTM). Adjusted EBITDA (TTM) for Sporting Products rose more than 3 times than Outdoor Products at $635 million against $188 million.

VSTO indicated that it will tailor its capital allocation strategy in Sporting Products to meet its debt repayment requirements as well as pay out dividends to shareholders. For Outdoor Products, the company aims at investing in organic growth and getting back to M&As. These two entities have different growth trajectories making it imperative to effect the separation in the calendar year 2023.

Sporting Products mainly includes brands such as Remington, Federal, Hevi-Shot, and Alliant Powder among others that deal with guns and ammunition. Back in 2019, Vista Outdoor explained that it sold its gun manufacturing business to Long Range Acquisition for $170 million. The sale was due to the spike in gun-related violence in the US. Still, the company remained with the bullet-production business that has risen with the increase in gun ownership.

Research has shown that gun ownership among US households has remained steady since the late 1990s. In 2022, about 45% of American households had a firearm in their possession. The increase in guns means more production of ammunition.

Growing the ammunition business

Back in October 2020, VSTO added Remington Ammunition to its fold which also included Speer and CCI saving the company from bankruptcy (at the time). VSTO’s sales were driven from $15 million in FY 2020 to $350 million annually. The company’s annual revenue has grown 78.37% since the FY ending in March 2021 to $1.13 billion from $633.7 billion. This M&A strategy has shown VSTO has been investing in more profitable ammunition ventures. Additionally, HEVI-Shot falls among the leading non-lead shotshell manufacturers in the US that also includes heavyweights such as Kent Bismuth, Winchester Blind Side Waterfowl, and Herter’s Waterfowl among others.

VSTO has reiterated that its sports product business has toned down on categories that are more politically driven and increased its stake in areas where demand is driven by usage. The company is looking at an overall industry consolidation with up to 16 million new firearm owners being registered since 2019. Also, it is likely VSTO’s shooting sports will expand outside shotshell as it seeks to secure more multi-year supply agreements with law enforcement and OEM customers.

Outdoor Products come off as a more customer-oriented segment. As earlier on seen, it is not as big as the Shooting sports business in terms of revenues. However, due to its direct-to-customer (D2C) capabilities, VSTO expects to leverage its scalability to improve pricing and upgrade service levels.

Earlier in Q1 2023, the company announced the acquisition of two new brands under its Outdoor Segment, Fox Racing, and Simms Fishing. At the time, VSTO was facing challenging macroeconomic headwinds caused by Covid19 but still managed to post 21% (YoY) revenue growth. Such acquisitions were affordable with an EPS of $2.31 and up to $100 million in free cash flow. At the center of this Outdoor segment are activities such as camping, grilling, electric bicycles, and hunting among other DIY projects.

In my view, the ammunition business has benefited from more affluent customers as compared to the Outdoor section. The latter touches on a broader social-economic spectrum enabling the company to drive strong earnings. This ability has unfortunately exposed the company to macroeconomic headwinds such as inflationary pressures.

Still, VSTO’s leading outdoor brands dubbed 12 Power Brands (including Simms Fishing- recreation and Fox Racing-action sports) can generate more than $100 million in annual sales and can be described as brands of the future. While Sporting Products recorded higher sales at $432 million in the quarter, it represented a decline of 4% (YoY). Outdoor Products revenues of $349 million represented an increase of 6% (YoY) from FY 2022.

Further, I believe that there is a direct correlation between homeownership and interest in outdoor-centered activities. These activities in the long run will become embedded in the American culture similar to gun ownership.

Risks to Consider

For Outdoor Products growth will be primarily driven by acquisitions as compared to Sporting Products which flows with market pricing. Further, sales growth may be hampered by product seasonality. For example, the sale of fishing products or other recreational devices may be limited during winter. Further, consumer spending may be hampered by rising inflation and interest rates. However, this situation may be partially offset by the increase in input and freight costs. VSTO’s annual costs rose 11% (YoY) to $107 million to cover the increase in inflation and interest rates. EBITDA for Outdoor products declined 11% (YoY) to $46 million while Sporting Products declined 23% (YoY) to $140 million. The decline was to give a hedge to maintain a lean selling and general administrative (SG&A) cost structure.

VSTO’s Outdoor Products holds a weaker capital structure as compared to Sporting Products. IN FY 2022, outdoor’s gross profit stood at $399 million against Sporting’s $712 million. Other business segment trends show a relatively lower marginal growth rate. Since the FY 2020, Sporting’s gross profit has grown 439.39% while Outdoor’s has surged 79.73%. Additionally, only 12 Power brands in the Outdoor segment have annual revenues above $100 million out of 34 brands.

Finally, VSTO’s total debt outstanding is $1.32 billion. The company’s cash reserve stands at $66 million meaning that the net debt is $1.254 billion. However, VSTO’s current asset balance of $1.391 billion and total asset balance of almost $4 billion is enough to provide security for the long term. Also, the net debt to adjusted EBITDA is 1.7X growing from 0.7X in Q1 2023. Despite this growth (due to an increase in debt), VSTO is still able to repay its debt in less than a year.

Bottom Line

VSTO has stable underlying business fundamentals as demonstrated by its strong net debt to adjusted EBITDA of 1.7X. The company’s intention to spin off its Outdoor business segment is a response to mitigate the challenge of inflation and high-interest rates. VSTO’s sporting sector remains the most dominant segment despite having fewer brands under its umbrella. The robust free cash flow enabled the company to add key brands to its Outdoor portfolio in Q1 2023. It is likely the company after the split will seek additional accretive acquisitions to boost the Outdoor brands. It only has 12 power brands out of 34 with the capacity to generate annual revenues more than $100 million. For these reasons, we recommend buying the stock.