Ammo Manufacturer AMMO, Inc. (NASDAQ:POWW) is a rare example of a growing business in a traditional industry. Founded in 2016, the company has multiplied its sales by 120 during the five years and posted strong net income in the last reporting period. In our view, the potential is not yet exhausted, with AMMO increasing its production capacity in a favorable market environment. The launch of the new Manitowoc Wisconsin plant is scheduled for next week, which will triple current mainline production. Additionally, POWW gained a key strategic advantage with the acquisition of Gunbroker.com. According to our DCF valuation, the company is trading at a significant discount to our estimate of fair market value. We price stocks as a buy.
Favorable market environment
Ammunition shortages are not a new phenomenon. Between 2008 and 2016, we have repeatedly witnessed high demand in the market, but the current shortage is unique in all of the factors influencing it.
The psychological stress caused by the lockdown and BLM protests were key drivers of growth in demand for weapons in 2020. In 2021, demand has reached a new level. According to the FBI, in 2021 the number of firearms background checks exceeded the 2020 figure by 10 million. Although the number of checks declined in the first half of 2022, the figure remains the highest on record, excluding 2020 and 2021.
In addition to strong demand, the ammunition market is experiencing a supply shortage due to supply chain issues and high raw material prices. Political factors also have a stimulating effect on the market.
If before the pandemic, the lack of domestic supply was compensated by imports, today, due to the disruption of supply chains, US imports of ammunition have fallen by 34%. The problem is exacerbated by rising commodity prices. Since the beginning of 2020, the prices of lead, copper, brass, nickel, zinc and steel have increased by approximately 5%, 48%, 66%, 72%, 36% and 21%, respectively.
New regulatory initiatives from the Biden administration are inspiring some of the ammunition market bears. However, let’s look at history. After Barrack Obama’s election in 2008, Americans began to buy guns and ammunition en masse for fear of further restrictions. The decline occurred after the election of Donald Trump in 2016. The arrival of Joe Biden in the White House again boosted demand. Thus, we believe that new regulatory measures or talk about them are an important driver of the growth in demand for arms and ammunition.
The ammunition market is very competitive. Today, there are 702 weapons and ammunition manufacturing facilities in the United States, most of which sell their products through distributors and large retail chains. Although current conditions are favourable, manufacturers will be forced to squeeze already thin margins on their products to maintain share in a highly competitive market when the market returns to equilibrium. Under these conditions, AMMO has a significant strategic advantage over the GunBroker.com marketplace, which the company acquired in May 2021 for $240 million.
Today, Gunbroker.com is the largest ammunition marketplace in the United States with 7.3 million registered users. First, its marketplace provides AMMO with a vast database of market trends in different parts of the country, which helps the company stay ahead of its competitors. Second, the company can sell its bales directly to customers, bypassing middlemen. Thus, AMMO becomes much more flexible in terms of pricing.
In 2021, Gunbroker.com added an average of 55,000 new users per month and enabled AMMO to achieve net profit faster as market profitability is higher than that of the manufacturing segment.
Profitability despite aggressive growth
Over the past five years, AMMO has grown its sales from $2 million to $240 million. The company ended fiscal 2022 with 284.5% year-over-year growth.
It is important that the growth potential is still huge. A new plant in Manitowoc, Wisconsin is set to open next week, capable of tripling current mainline production. In addition, AMMO plans to eventually double the production capacity of the new factories by deploying additional equipment already owned by the company. Management expects POWW’s market share to double in the next 2-3 years.
Despite aggressive growth, AMMO posted a net profit in 2022 for the first time. The gross margin increased from 18.2% to 36.9% over the period. The operating margin for the same period is 15.5% against -8.6% a year earlier. The net profit margin increased from -12.5% to 13.8%. Management expects adjusted EBITDA for fiscal 2023 to be $108-111 million versus $80 million this year, implying margin growth of 32% to 36%.
We expect the company to continue to improve its profitability: first, by increasing production capacity and realizing economies of scale; and second, by reducing transportation costs, since the new Wisconsin plant is located next to the brass manufacturing plant.
Valuation of POWW shares
Our DCF model is built on certain assumptions. We expect revenue growth in line with the Wall Street consensus over the next two years, followed by a slowdown to 4%, in line with the terminal growth rate. Based on management’s expectations, we forecast margins for next year and assume the figure will hold until the end of the forecast period. The assumptions are presented below:
With a cost of equity equal to 10%, the weighted average cost of capital [WACC] is 9.9% because AMMO has low financial leverage.
Although our model is very simplified and does not take into account the significant increase in margin expected after the Wisconsin facility reaches full capacity, it projects a fair market value of $741 million, or 6.4 dollars per share. Thus, the upside potential is around 51%. Notably, our target price is below the Wall Street consensus of $8, implying over 90% upside potential.
In our view, AMMO represents a rare growth opportunity at the cost of a valuable business. Although the results of the past few years have been impressive, the potential remains and the company is able to maintain a high rate of growth as the new plant in Manitowoc, Wisconsin will triple current mainline production. The company has already achieved profitability and therefore can hardly be called a high-risk case. According to our estimate, AMMO is trading at a significant discount to the fair price.