Vista Outdoors Sporting Division Spin-Off (VSTO)
Recently announced spin-off of Vista Outdoors Sporting Division presents an opportunity to purchase their ammunition business at a bargain price.
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Welcome to Special Situation Investing Episode 26. Today we will look out
several months in the future to discuss the recently announced spin-off of
Vista Outdoors sporting segment scheduled for calendar year 2023.
Vista Outdoor, ticker symbol (VSTO), is a 2 billion market cap company that
can be broadly divided into two parts. Part one, engages in the sale of
outdoor sporting equipment with brands like CamelBack, Bell, Blackhawk,
Bushnell, Giro, and Camp Chef to name a few. Part two of the company, which
will be renamed after the spin-off, encompasses Vista's Sporting segment
which includes the following ammunition brands Alliant Powder, CCI, Estate
Cartridge, Federal Premium, Hevi-Shot, Remington, and Speer.
What caught my eye about this spin-off was the profitability of the sporting
segment. Remember that the sporting segment is the "bad" part of the
business that's being spun off and renamed while the outdoor business will
be retained and led by Vista's current CEO. To illustrate the difference in
profitability, I would highlight that the sporting segment accounted for 1.7
billion in sales last year with the outdoor division producing nearly as
much in sales, at 1.3 billion. Take those similar sales numbers, however, and
note that the sporting division brought in 700 mm in gross profit compared
to only 400 mm in gross profit for the outdoor division. The gross profit
margin of the sporting segment in 2022 came in at a solid 41% compared to
30% for the outdoor division.
Given the superior margins of Vista Outdoors sporting segment, why would the
company want to divest it? In my opinion, outside pressure to divest firearm
related companies is the driver in this decision. Consider the following. A
recent USA today article recounted Nevada's state treasurer Zach Conine's
decision to divest from companies who profit from "the manufacture and sale
of assault-style weapons" as they "present a market risk I'm not willing to
take." If approved at the upcoming state Board of Finance meeting, Nevada
would be the fourth state to take such action. Large public funds, like the
California Public Employees Retirement System (CalPERS), control a tremendous
amount of capital that, if they followed, a similar path could seriously
restrict capital flows into publicly traded firearms companies.
Black Rock, the world's largest investment company, is also moving to divest
firearm companies. In a March 2018 press release, Black Rock made clear that
they will "offer their clients products that exclude firearms manufacturers
and/or retailers" and further that they will "engage with firearms
manufacturers and retailers in which our clients are invested regarding
business policies."
Vista Outdoors is by far the largest publicly traded ammunition company in
the US. The only other significant ammunition brand owned by a public
company is Winchester which is owned by Olin, a large chemical company.
Winchester is a very small percentage of Olin's business and it wouldn't
surprise me if they spun Winchester out in the years to come for the same
reasons that Vista is spinning out its sporting division. Given the size of
Vista's ammunition business it's a huge divestment target for socially-conscious funds.
Strum Ruger is the largest publicly traded gun company in the US with a 1.2
billion market cap, and despite its steady earnings, only commands a P/E of 8.
Smith and Wesson is the second largest publicly traded gun manufacturer at a
700 mm market cap and sits at a P/E of 3. Now granted, both companies
generated record profits during the last two years and they would trade at
mid to high teens multiples if you used their lower earning numbers from
2018 and 2019 but a case can be made that the market is discounting both
companies on a moral and ethical basis and not a financial one. If the same
discount is applied to Vista's sporting segment spin-off, it could create a
buying opportunity for individual investors.
For several reasons I believe that the ammunition business is superior to
firearms. For starters, ammo is much easier to manufacture and ship than are
weapons. From design, to manufacture, to shipping and delivery, the process
of shipping a weapon is significantly longer than is the delivery of
ammunition. While some R&D goes into the development of new ammo most of the industries research is geared toward improvement of the weapon itself. Furthermore,
assembly of the weapon is a more involved process than manufacturing ammunition. Consider how many more sportsman reload their own ammo versus
the number who gunsmith their own firearms. Finally, shipping a weapon
requires a background check on behalf of the purchaser and demands that the
weapon first be shipped to a Federal Firearms Licensed (FFL) dealer
intermediary before the customer takes ownership of the weapon. Contrast
that with the ease of ordering ammunition online and having it shipped
directly to your home without the background checks and FFL middle man and
you can see how much shorter the supply chain is from manufacture to
customer in the ammo space.
At the risk of sounding like a broken record on inflation, here is why the
supply chain length matters. A business pays its input and labor costs
upfront but its profit margin is determined by the markup on its product at
the time of sale. In an inflationary economy long supply chains and
manufacturing timelines mean that input costs are rising throughout the
supply chain delay and manufacturing timeline process and that whatever
markup a consumer charges is eaten up by increased input costs at the start
of its next manufacturing cycle. The producer is constantly losing
purchasing power as it creates goods and services and must turn around and
constantly pay higher input costs to keep the business running. If you can
shorten the timeline from input cost to sale and delivery then inflation has
less time for the owner's purchasing power to degrade before new input
materials are purchased.
A second reason the ammo business is superior to firearms is that ammo is
consumable and tailorable. A well-made gun lasts for generations, but ammo,
if used for the purpose it was created, is a high-turnover item. A single
weapon can shoot thousands of rounds of ammunition over its useful life,
meaning that Smith and Wesson makes a single sale compared to the thousands
of sales made by the ammo company. I also mentioned that ammo is tailorable
and here is what I mean by that. At several hundred dollars for even a
modest gun that purchase can be a significant one, but ammo on the other
hand can be purchased in very small amounts. This means that a customer
without enough cash to purchase a new gun can easily pick up a box of 50
rounds of ammo meaning that again the ammo maker makes a sale and Smith and
Wesson does not. Higher sales on a high margin item make for a better
business even if the item in questions sells for lower price than its lower
margin, low turnover, counterpart.
Finally, a sizable chunk of Vista's ammo business is via contracts with
military and law enforcement. In Vista's 2022 annual report the company
validated its support for military and law enforcement by stating that
nearly 10% of their revenue was derived from that group. At this point I
make a few assumptions, but nothing that's too much of a stretch. For
starters, I don't think that a great deal of that 10% of revenue comes from
bicycle helmets and camping cookware in the company's outdoor division. It's
safe to assume that most of that 10% is made up of ammunition sales. Now
because ammunition is around 50% of Vista's revenue you can infer that about
20% of Vista's ammunition sales are military and law enforcement contracts.
This matters for the very obvious reason that government spending tends to
be unaffected by economic cycles. The NYPD will likely purchase the same
amount of ammunition in any given year because their training program
demands it regardless of broader economic factors. Additionally, military
and law enforcement won't be effected by gun legislation that impacts
private customers. Even if the ordinary person can't buy this or that type
of ammo due to changing laws, the government will continue to purchase it to
meet its training requirements.
Now, why would an abandoned ammo company present an investment opportunity?
If the stock is oversold post spin-off and forever after trades at a low
multiple shouldn't we stick with the crowd and avoid it? I would suggest
that, no, we shouldn't. In the spirit of Howard Marks you can't say an
investment is a bad one regardless of the price. Even if the stock forever
traded at a low multiple if it generates high returns on capital you may be
able to make money just the same. The company could dividend the profits out
or slowly buy up its stock leaving each shareholder with higher and higher
earnings per share even if those earnings command a low multiple.
With that said I would contend that this spin-off is one to watch for a post
spin-off purchase. I have no real interest in owning the outdoor section of
Vista Outdoors, so purchasing it prior to the spin-off doesn't accomplish
much for me. Furthermore, I anticipate a lot of institutional selling of the
ammo business post spin for all of the reasons listed above. If the sporting
division is over sold down to a 2x or 3x enterprise value to free cash flow
then I'll purchase shares in the company. I use enterprise value in this
analysis because it adds the debt of the company to the total value and
because we don't yet know how much debt Vista will dump onto the sporting
division.
I will keep an eye on this spin-off and provide an update as Vista releases
more information. I expect that Vista will provide pro-forma accounting
statements ahead of the spin-off that show just how much free cash flow they
expect the sporting segment to generate and guidance on the amount of debt
that the spin-off will be saddled with. These two pieces of information
should be enough to value the company and determine a buy price ahead of the
spin-off.
With that I hope you learned something in today's analysis of the pending
Vista Outdoor spin-off. Remember that you can always support us by signing
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listening and I look forward to bringing you another write up next week.
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