Ben Mahaney, Editor

About the Author Ben Mahaney, Editor

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Sportsman’s Warehouse: Too Many Bullets To Dodge?

Sportsman’s Warehouse (Nasdaq: SPWH) looks an awful lot like a sitting duck right now. Since its largest pure-play competitor has already shot off its mouth about the “wickedly competitive” nature of the recent holiday season ahead of the company’s fourth-quarter report, SPWH must feel like it’s treading water with the equivalent of a neon target on its back.

Unless SPWH somehow managed to dodge a relentless slew of bullets over the holidays, in fact, the company has probably spent the past couple of months in serious pain. We should know for sure in a matter of weeks.

With rival Cabela’s (NYSE: CAB) slashing its prices in order to steal business away from the competition during the crucial holiday season, however, SPWH sure looks vulnerable to a devastating miss. Just listen to some of the noisy warning shots fired by CAB earlier this month, and imagine the fallout that SPWH likely suffered as a direct result.

We felt like when we talked to you guys in October that it was going to be a promotional environment, and we felt pretty good about our November and December promotional cadence. [But] as we started getting into November, it became very clear that it sure felt like there was a lot less consumer disposable income. And retailers, mostly outside of our space, really started cranking up offers – to the point that some were almost ridiculous – weeks ahead of Black Friday. We just felt like, to protect our franchise and to maybe be opportunistic and take share, we had to jump into the fight. And what that meant was it took more discounts, as the consumer was very promotionally minded in the quarter.

It was definitely a war for the customer’s dollar in November and December, [AND] I don’t think we were unique in feeling the unbelievable pressures… It was a wickedly competitive environment. [SO] we used our leadership position to get in the fight – which a lot of our competitors can’t. And that was kind of the story of the quarter.

While we didn’t feel great about the earnings impact, we definitely took it to people from a share standpoint… During the quarter, we were able to grow market share in almost all of our major merchandise categories. We are pleased with our ability to grow share during the quarter and further pleased we have seen this trend continue into the first quarter of 2015.

It’s a whole new world, with affiliate networks and mobile apps and comparison shopping engines and all of that stuff. And I don’t think the promotional environment in the fourth quarter of THIS year – unless the economy improves greatly – will be much less intense.

Adding Salt to a Fresh Wound

Even the bullish analysts who recommend the company’s stock felt blindsided enough by those dismal fourth-quarter results to express some measure of concern. Take a look at their blunt commentary below.

SunTrust Robinson Humphrey said,

“We were worried about the Q4 release, but the news was still worse than we had expected.”

As per Felt & Company,

The company was promotional during the quarter, which helped it take market share, but we think this impeded sales and margin… We think the company is in a much more difficult competitive environment than it has faced over the last several years and will need to continue to be aggressive on promotions to drive traffic and sales.

As per Stifel ,

While we noted a more promotional tone during the holidays, advertising expense was much higher than expected… CAB took a more aggressive approach to promotions, driving market share at the expense of merchandise margin… In combination with the still-challenged comp, this signals ongoing traffic challenges.

Credit Suisse states,

These issues were known, but the magnitude was worse, and it is not clear if that has and/or will continue in 2015, or if there was some pull-forward element. [Management] commentary suggests a ‘normalization of firearm and ammunition sales.’ However, much of that improvement was supported by investments in the form of promotions and advertising, which is a concern… How much of the improvement in firearm and ammo comps has been supported – and perhaps inflated – by promotions? And will that really have to normalize at some point?

Misfiring When it Matters the Most

For its part, SPWH must have felt surprised to see CAB take such drastic measures in an effort to salvage its all-important holiday season as well. After all, when SPWH hosted its third-quarter conference call back in early December – with the Christmas shopping season already in full swing – company executives insisted that they had yet to see any signs of that sort of danger.

The CEO assured at the time,

We have seen nothing in terms of promotional cadence that would tell us there is going to be any impact on margins. I have yet to see, at least on an anecdotal basis, any national player really giving up a whole lot of margin. [Indeed], other than from the Mom-and-Pops, we didn’t see any real increase in promotional cadence at all.

To skeptical investors – including TheStreetSweeper itself – SPWH looked too optimistic for its own good, even before CAB forced the company to open up its eyes. On the final day of the holiday shopping season, in fact,TheStreetSweeper sounded a loud alarm about SPWH, after uncovering all sorts of potential risks. Less than two weeks later, a fellow critic took an even bolder stand by urging investors to sell SPWH short ahead of a likely miss that could hammer the company’s share price.

Let’s revisit that bearish call, now that we know just how brutal the crucial holiday season proved to be, and see if that warning sounds even more relevant today.

Dallas Salazar wrote in an article published by Seeking Alpha Pro more than a month ago,

Heading into Q4, I think that if SPWH doesn’t have a fantastic holiday shopping season that, based on Q3 results, the market will sell off shares hard on the realization that an expanded inventory – comprising a whopping 87% (ex. PP&E) of SPWH assets – will then need to be discounted for immediate sale to help fund operations at the company.These inventories need to be turned into cash to prevent complete reliance on further debt and to help meet borrowing covenants on the company revolver that calculate borrowing base as a percentage of the inventories’ values.

Talk about a hairy situation. SPWH has already dug itself into such a deep hole that its outstanding liabilitiesat 8.03 times its projected EBITDA – look almost as daunting as those incurred by a rival chain that’s literally on the brink of default.

Recently hit with a three-notch downgrade that sent its credit rating deep into junk territory, The Sports Authority has saddled itself with an onerous debt burden that (at 8.25 times its earnings) closely resembles SPWH’s own. Notably, when Moody’s issued that downgrade a few days ago, the firm specifically cited the company’s high debt-to-income ratio as a reason for concern.

Moody’s noted in an article published by Bloomberg last Friday,

At these operating levels, Sports Authority’s capital structure is unsustainable over the longer term. And the risk of a default, including a distressed exchange, is high, given the upcoming maturities.

Despite the onerous nature of its existing debt load, SPWH actually took deliberate steps to raise its credit limit, so that it can borrow even more money than it already owes. Don’t rule out the possibility of a dilutive secondary offering, though. SPWH looks so highly leveraged at this point, in fact, that some investors simply assume that the company will run out of other options pretty soon.

Granted, if SPWH falls short of Wall Street estimates for its most important quarter of the year, its stock could easily tank before the company ever gets a chance to make that sort of move. No wonder so many skeptical investors have decided to bet against SPWH, ahead of that looming quarterly report.

Salazar explained last month,

I find that a short position in SPWH heading into Q4 earnings offers a near-term catalyst for driving shares lower, as I feel comp sales will miss to the downside as a result of several factors that weren’t indicated as potential risks to operations by management on its most recent investor call, prior to the Q4 holiday selling season.

Blowing up a Popular Myth

With investors understandably spooked by that report, SPWH began to steadily lose ground – ultimately shedding 17.5% of its value in the two weeks that followed – before the stock finally reversed course and rode a fresh wave of hope back to its previous levels. At this point, however, that celebration looks a bit premature. Despite a favorable swing in the data compiled by the National Instant Criminal Background Check System (NICS), investors cannot safely assume that the recent uptick in FBI background checks will automatically translate into a rebound in gun sales, any time soon.

Even SPWH itself knows better than that.

The CEO reminded just a couple of months ago,

A very important concept to keep in mind is that NICS data is reported on a unit – not a revenue – basis. This is important, since during the third quarter, the adjusted NICS numbers grew by 3% for the states in which we have stores. On a unit basis, our firearms increased by 3.1% from Q3 of last year. [However], we recognized an overall decrease in net sales in firearms, because unit pricing decreased with many vendors, as a result of increased promotional pricing.

With the big gun makers themselves reporting far more striking disparities between FBI background checks and actual gun sales, some industry experts have started to question whether NICS data even serves as a useful measuring tool anymore.

KeyBanc noted in late January,

While much has been made of the recently positive inflection in NICS over the last several months and its use as an indicator, we found it harder to reconcile this data point with what our contacts were seeing from the respective industry viewpoints, with many continuing to deemphasize NICS as a proxy and calling out an increasing number of nuances, such as new vs. used sales mix, private-party transactions and – most notably – the unit vs. price dynamic that has been driven by aggressive promotions.

Firing a Round of Warning Shots

That Wall Street firm clearly sees little reason to hope for a near-term recovery, in the very industry that SPWH happens to depend upon the absolute most. Indeed, after KeyBanc analysts hosted meetings with a number of players involved in the gun industry – from those responsible for manufacturing the weapons to those that (like SPWH itself) actually sell those products to the public – KeyBanc loudly warned investors to brace themselves for a lingering downturn, that could literally stretch into early next year.

KeyBanc cautioned,

We believe firearm inventories will continue to create industry headwinds for at least another 6 to 12 months. We also see this dynamic creating a slippery slope for pricing that could have longer-term ramifications, with the majority of our contacts struggling to predict when pricing would ultimately bottom and begin to recover…

KeyBanc further declared,

An emerging and increasingly uncertain theme at the [trade] show was the pervasive level of firearms discounting and its longer-term impact on structural pricing levels, as the industry progresses towards a new normal, after several years of exceptionally strong pricing power. To that end, we see this dynamic fostering a ‘race to the bottom’ mentality over the coming months, as competition rema

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