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Smith & Wesson & Ruger losing share to Glock; SWHC4Q13 earnings preview

6/17/2014

Smith & Wesson Holding Co. (SWHC) - $16.67Sturm Ruger & Co. (RGR) - $60.69

Why Read?

Smith and Wesson’s earnings are out this Thursday June 19th, after the close. We expect SWHC toreport a strong quarter but see their dominance in the subcompact handgun market beginning to wane.

We expect greater competition from the Glock 42 will lead to decelerating handgun sales in 2H CY14and slight margin compression. We remain LONG SWHC // SHORT RGR with higher conviction inthe short RGR side of the trade.

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!  NICS checks decreasing but handguns sales still strong:  Sequentially adjusted NICS havecontinued to decelerate. TTM adjusted NICS were -1.0% in February, -2.1% in March, -5.4% inApril, and -7.6% in May. Checks show continued strength in handguns over long guns.

!  Share redistribution shifting towards Glock:  Handguns sell in 12-18month cycles, where onebrand will command the marketplace until the next “hot” handgun hits the market and enters fullproduction. RGR was the first to command the concealed carry/women’s market with their

LCP380. SWHC countered with their M&P Shield and Bodyguard lines, which have quicklybecome the most popular selling concealed carry handguns. The Glock 42, a single stack .380concealed carry pistol is expected to be the next “hot” gun. In March (see note onwww.consumerfoxresearch.com), when we last did a large survey of handgun sales, SWHC camein as the clear winner with the M&P Shield and Bodyguard lines dominating the subcompactconcealed carry market. In our more recent, yet smaller, survey Glock is the commanding leader inthe subcompact concealed carry market with 60% of the stores survey responding the Glock 42 isthe bestselling subcompact handgun.

!  Production catching up with demand: One key take-away from our most recent survey was theproduction of the SWHC M&P Shield and Bodyguard lines have fully caught up to demand. We

expect to see a lowered backlog going forward as well as increased promotions at the retail level.

!  SWHC Estimates: For 4Q13, we expect SWHC to report $167.5m in sales versus a consensus of$163.5m and a management guide of $159m-$164m. For 4Q13, we expect SWHC to report EPS of$0.44 versus a consensus of $0.39 and a management guide of $0.37-$0.40. For 1Q14, we expectSWHC to report $161.9m in sales versus a consensus of $160.6m. For 1Q14, we expect SWHC toreport EPS of $0.41 versus a consensus of $0.40. For FY14, we expect SWHC to report $619m insales versus a consensus of $621.8m and EPS of $1.47 versus a consensus of $1.45.

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Glock taking share from SWHC & RGR:

Location In stock?Ruger

380

SWHCM&PShield

SWHCM&P

Bodyguard Glock 42 Best seller

Mitchell, South Dakota Cabela's yes yes yes yes Glock 42

Post Falls, Idaho Cabela's yes yes yes yes Glock 42

Wichita, Kansas Cabela's yes yes yes no Glock 42

Louisville, Kentucky Cabela's yes yes yes yes Glock 42

Waco, Texas Cabela's yes yes yes yes Shield

Scarborough, Maine Cabela's yes yes yes yes Shield

Lehi, Utah Cabela's yes yes yes yes Glock 42

Springfield, Oregon Cabela's yes yes yes no Glock 42

Agusta, Georgia Cabela's yes yes yes no Shield

Gonzales, Louisiana Cabela's yes yes yes no Shield

Total In stock? 100% 100% 100% 60% Glock 42 - 60%

Production catching up with demand:

Handguns typically sell in 12-18month cycles. Most new products are released to buyers at the annualSHOT show in January. We expected the M&P shield to dominate sales further into the year but ourchecks have shown the Glock 42 production has become much more robust compared to even march.During our checks in March, only 79% of the stores surveyed had the M&P lines and only 4% had thenew Glock 42. In our most recent June survey, 100% of the stores surveyed had the M&P in stock and

60% had the Glock 42. With the Glock 42 being this year’s hot gun, we have observed greaterpromotions for the M&P Shield line.

“   I really like the Shield, they are on sale right now. But otherwise we sell more Glocks.”   Cabela’s,

Scarborough, ME  

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More testimonials for the Glock 42:

“The Glock 42 is the best [selling], If I display them they’ll be gone in an hour " –

Cabela’s, Springfield, Oregon

“The Shield’s newness is wearing off. Glocks come and go in a matter of minutes; shipments

are still light on those. We have five at the moment [Thursday] but they will be gone by the

weekend." – Cabela’s, Louisville, Kentucky

Conclusion:

With a 31% short interest, SWHC is still a very controversial name. The bear case is quite simple; gunsales cannot stay elevated forever. Many of the bears expect a collapse in sales will lead to marginnormalization and significantly reduced earnings power. In FY2013 earnings increased 210% on top of43% topline growth. While we expect gun sales to decrease, we believe this last product cycle and boomhas significantly benefited manufactures, such as SWHC, who focus on the concealed carry and homedefense products. We expect SWHC to continue to outperform for the next two quarters. Going into 2HFY14, we expect the name may soon become a short candidate itself. Otherwise we believe, more nowthan ever, this is an excellent time to short RGR. RGR is clearly the biggest loser in the subcompactmarket and their once popular LCP380 model was barely mentioned in our most recent survey.

Disclaimer: The information contained herein reflects the views of Consumer Fox as of the date of publication. These views

are subject to change without notice at any time subsequent to the date of issue. All information provided in this presentationis for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sellthe securities mentioned or to invest in any specific security or investment product. While the information presented herein isbelieved to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition,there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trade-marks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over theiruse. This presentation is confidential and may not be reproduced without prior written permission from Consumer Fox. Itshould be noted that Consumer Fox has no position in any security of the company mentioned in the report/presentation.