Will FBI Background Checks Help or Hurt American Outdoor Brands Stock?

By Rich Duprey Markets Fool.com

Now that Smith & Wesson's parent American Outdoor Brands (NASDAQ: AOBC) has reported third quarter results that take into account the effects of the November elections, it's becoming clear just how hard a landing the firearms industry is experiencing.Sales that started the quarter off strong weakened as the period progressed, and now, the reality of lower gun demand is catching up.

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The FBI will soon be reporting its National Instant Criminal Background Check System (NICS) numbers for February, which will give investors an indication of just how severe the downturn will be, and there are some indications it won't be pretty. American Outdoor, which saw its stock shed about 4% after the earnings report, may see its shares decline further.

Image source: Smith & Wesson.

No longer on target

The firearms manufacturer said fiscal third quarter sales rose almost 11% to $233.5 million from $210.8 million a year ago, within management's guidance range of $230 million to $240 million but at the low end. However, the fall off in demand was so dramatic that management has had to revise its outlook for the full year. Where it previously guided for sales of $920 million to $930 million, it now anticipates sales to be between $874 million and $894 million.

December's NICS numbers were down 16% year over year, which wasn't unexpected, but the degree to which January's sales declined -- another 20% -- caught everyone off guard. Now, all eyes are on the February numbers.

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Last month, industry peer Sturm, Ruger (NYSE: RGR)reported fairly robust sales for the quarter with net sales rising 21% year over year, but like American Outdoor Brands, noted the drop in demand and the effects it was having on inventory levels. Both have experienced above-normal increases in inventory, and it's going to be affecting production as retailers aren't seeing the same customer traffic they had enjoyed previously.

Weakness across the board

Though troubled retailers like Cabela's and Gander Mountain, which is reportedly contemplating bankruptcy, are big gun sellers, neither American Outdoor nor Ruger anticipate any long-term negative effects. They've either factored in potential problems, as American Outdoor has done with its earnings guidance for the fourth quarter, or don't sell directly to the outlets, like Ruger, which uses distributors.

Yet that doesn't mean they won't be affected if several million square feet of retail space is taken out of the marketplace. Of more immediate concern might be the direction the FBI background check data will take.

By and large, it's going to be down year over year, but the degree of decline is what might cause American Outdoor Brands' stock -- and Ruger's too -- to take the news hard. And the drop may be even worse than what was seen in January.

A chill wind

Historically, February has been a stronger month than January with sequential increases in the number of background checks performed occurring in 17 of the last 18 years. However, Feb. 2016 was a record-setter with more than 2.6 million conducted. That was the fourth largest amount performed in any month of the year, bested only by December in 2012, 2015, and 2016, and it was 13% more than the previous February record, which occurred in 2013.

Data source: FBI. Chart by author.

With the weakness being experienced in the firearms marketplace, it's likely the drop will appear especially steep, even if it's really just a return to normal demand levels.

Ruger CEO Mike Fifer doesn't think it's going to be as bad as previous industry downturns.But as American Outdoor Brands CEO James Debney noted, there was a major shift in gun buyer preferences this past quarter, moving away from handguns and to long arms. Where handgun sales were down 19%, long arm sales were off just 2%.

Data source: FBI. Chart by author.

That shift could benefit Ruger, which makes three times as many rifles as Smith & Wesson, and Savage Arms, the rifle and shotgun manufacturer owned by Vista Outdoor (NYSE: VSTO), which produces twice as many long arms as its rival.

That means the shift American Outdoor Brands made to target the rugged outdoor space could help smooth out such volatility over time, but the transition is still in its early stages, and investors should brace for the worst when the FBI releases the latest numbers.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.