Shareholders have had a horrid time with Vista Outdoor (VSTO), and understandably no longer have the enthusiasm, patience or willingness to look at Vista with a fresh pair of eyes. However, I am taking the bold view that Vista offers investors a great bargain at today’s price.
I don’t wish to regurgitate all the history that got this company here trading near all-time lows. That is dull for you to read, and arguably duller for me to regurgitate it. I’m highly confident that you can read it right here on SA much better described than I can put it down for you.
In investing, we all look at totally different things to derive an understanding of whether a business is indeed trading at a discount to fair value or not. Personally, I have a preference for focusing on companies that have run into non-permanent troubles, looking to right themselves by undergoing asset sales in an attempt to de-lever their positions – this, together with the correct price, nicely describes Vista today.
In the business world, leverage gets a bad reputation. However, a certain amount of leverage works wonders. In Vistas case, the question is, just how much is a certain amount of leverage? I don’t know. What I do know, is that Vista is presently leveraged at 5.4X and that is way too much.
Realistically, Vista needs to get its leverage below 3.5X or better. Given that Vista finished YE 2018 with a net debt of roughly $900 million, Vista needs to get its net debt position to at least $600 million, and preferably better. Having said that, management did highlight its ambition to get Vista down to 2X-3X leverage – which I trust, most investors would be reasonably satisfied with.
Now, how does management intend to bring down its debt? Through selling some of the assets, for instance, Vista’s Sports Protection brands (e.g. Bell, Giro, and Blackburn), Jimmy Styks paddle boards, and Savage and Stevens firearms. Furthermore, expected to complete within the next few quarters, is Vista’s eyewear business consisting of the Boll茅, Serengeti, and C茅b茅 brands, which is expected to bring in roughly $158 million.
Further, this might sound obvious, but these asset sales will be foregone opportunities. Thus, going forward, Vista will be a smaller company, with less revenue. However, managements ambitions are that after Vistas fiscal 2019, going into fiscal 2020 (the next calendar year) that Vista will have better EBITDA margins, with roughly 10% EBITDA margins versus 7%, which it expects to finish fiscal 2019 with.
Vista is a cyclical business. Management said that its business is facing tough headwinds, with economic contractions, which have lasted roughly 15 months and that investors should not expect them to ease up in the next 6-9 months. Reading in between the lines, management alludes to the fact, that this contraction could actually last another further year. However, that Vista expects to come out of this period significantly leaner, in part through its efforts to bring down procurement costs and optimise its G&A structure.
Additionally, management highlights that customers had been stockpiling inventories and that it will take time for this inventory level to come down. Moreover, further compounding Vista’s profit margins is the fact that commodity prices have increased and that Vista has not been able to fully offset the increase in raw materials with higher average sales prices – CEO Metz went so far as to highlight that Vista operates in a highly ‘rational environment’, with few options at its disposal.
Investors look at a wide range of metrics. I like to look at free cash flow margin (FCF/Rev expressed as a %). I find that free cash flow margins above 5% often approach a return on tangible invested capital of 15% (very approximately). With higher FCF margins, describing better the business. Thus, as the table below shows, Vista has normalized FCF margins of 5%-6%, implying a reasonably high-quality business.
Source: Author’s calculations, morningstar.com
Vista guides fiscal 2019 free cash flow of $55 million to $85 million. Let’s assume that it ends up at roughly $60 million; this would make Vista’s present market cap on a 14X multiple to free cash flow. However, this is during a trough year and as discussed above, management seeks to delever its balance sheet by my own estimate to a ballpark of $550 million. Consequently, this factor alone should bring down its interest repayments from approximately $50 million down to roughly $40 million or even slightly lower, and closer to the $30 million it previously had during fiscal 2015-2016.
Source: Author’s calculations, morningstar.com
The table above shows some of Vista’s peers. Obviously, its closest publicly traded companies are Sturm Ruger (RGR) and American Outdoor (AOBC), with Dick’s Sporting (DKS) a distance competitor.
As we can see in the table, Sturm Ruger’s P/S ratio is close to its own historical average. On the other hand, American Outdoor is trading at a small discount. However, if we look over Sturm Ruger’s financials, in particular, we can see a company which has little control over its financials. As for American Outdoor, it is a far superior company compared with Sturm Ruger, as represented by great financials and strong returns on capital. In fact, objectively speaking, American Outdoor has significantly better returns on tangible invested capital than Vista too.
However, the reason why I’m bullish Vista is that its valuation is simply cheap. Its present P/S ratio stands at 0.4X and its P/operating cash flow is roughly 3-4 times. However, looking back, its P/S ratio used to be around 1X and its P/Cash Flow around 10-13X, once again emphasizing the cheapness of its stock at the moment.
Fiscal 2018 proxy form is not out yet. However, if we compare fiscal 2016 with fiscal 2017, we can see that insiders, as a group, have increased their ownership in the company by 15%. Also, we can see that throughout fiscal 2018 many insiders have bought the company’s stock in the open market. Finally, subsequent to year-end, now in May 2018, in the days after earnings were released and several insiders have bought into the stock.
Insiders such as CEO Metz, CFO Lopez and a couple of directors bought the stock. In fact, looking in more detail at these insiders, we can see that some of these insiders have only sold stock in the companies they worked at; thus buying at Vista marks a strong reversal from their usual stance.
Vista appears to be making the correct announcements and attempting to move in the correct direction. Given that management is willing to put its money where their mouth is, I argue that shareholders might benefit also.
Disclaimer: Please do your own due diligence to reach your own conclusions.
Note: The only favor I ask is that you click the “Follow” button, so I can grow my Seeking Alpha friendships and our Deep Value network. Please excuse any grammatical errors.
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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.
Additional disclosure: No positions in the stock, but I may go long over the next few weeks.