Forward View Initiates On Sturm Ruger With A Hold Rating, $53 PT

Whenever firearms are discussed, Smith & Wesson Holding Corp (NASDAQ:SWHC) is invariably mentioned. The name is emblazoned in our culture as a symbol of leadership in the gun industry.

What may surprise some, even though SWHC is the industry leader in pistol sales and more than 100 years older, is that Sturm Ruger & Company Inc (NYSE:RGR) was the leading manufacturer of firearms in the United States until 2015.

Ruger has maintained a solid lead in the last five years.

Table 1: Firearms Produced by Type (2014)1-5

2014 Pistol Revolver Rifle Shotguns Total Handguns Total Firearms
Ruger 722,029 281,430 706,192 4,446 1,007,905 1,714,097
S&W 914,700 268,722 159,276  0 1,183,422 1,342,698
Remington 65,771  0 929,823 413,535 479,306 1,409,129

 

Table 2: Total Firearms Produced (2010-2014)1-5

  2010 2011 2012 2013 2014
Ruger 903,968 1,114,687 1,651,975 2,180,780 1,714,097
Remington 555,794 1,026,860 1,162,744 1,401,380 1,409,129
S&W 681,834 857,043 1,124,767 1,505,963 1,342,698

 

A key takeaway from this data, besides defining that Ruger is an industry leader, is that the gun industry is extremely volatile. Figure 1 presents the percentage change of firearm production for the three manufacturers combined and Figure 2 shows the change for the three leaders individually during the periods between 2010 and 2014. These figures show not only volatility in the industry but between companies as well.

 

Firearm companies have not behaved rationally (as defined by the market) in the last few years. The recent swings in firearm production and sales have correlated to events during President Obama’s two terms.

Any time gun control has been mentioned, gun sales have risen sharply. Whether or not these purchases have been rational decisions we leave to the reader, but suffice it to say we believe the wild swings will end during the Trump administration as he strongly supports the right to own a firearm.

Table 3 shows the performance of both RGR and SWHC stocks in the weeks before, during, and after the election (November 9 is bolded as it was the first trading day after the election). It’s apparent the markets were expecting a Clinton victory and further stockpiling of weapons by gun enthusiasts. When this did not occur, each stock dropped almost 20% and, as of November 14, each is now beginning to rise to what we believe will settle at their fair value. We expect, during the next four years anyway, the firearm stocks to be more fundamentally driven.

 

Table 3: RGR and SWHC Stock Performance During Election Cycle6

Date RGR % Gain/Loss SWHC % Gain/Loss
11/1/2016 $60.70   $26.06  
11/2/2016 $61.85 1.89% $26.32 1.00%
11/3/2016 $62.35 0.81% $26.69 1.41%
11/4/2016 $63.90 2.49% $27.24 2.06%
11/7/2016 $63.85 -0.08% $27.85 2.24%
11/8/2016 $64.40 0.86% $28.45 2.15%
11/9/2016 $55.10 -14.44% $24.12 -15.22%
11/10/2016 $48.45 -12.07% $21.98 -8.87%
11/11/2016 $47.50 -1.96% $21.24 -3.37%
11/14/2016 $50.75 6.84% $23.58 11.02%

 

Much like firearms produced, the firm’s sales have not gone in a linear manner. Interestingly enough, even during the “downturn” of 2014, sales were still more than double from that in 2010.

Table 4: RGR Sales (Millions)7,8

  2011 2012 2013 2014 2015
Rifles $83.40 $143.90 $217.60 $203.90 $208.50
Pistols $150.00 $216.50 $293.50 $198.20 $192.20
Revolvers $69.90 $92.70 $108.20 $112.80 $113.30
Accessories $20.20 $31.80 $59.30 $23.90 $30.30
Casting Products $4.62 $6.90 $9.70 $2.20 $6.20
Total Sales $328.12 $491.80 $688.30 $541.00 $550.50

 

Investment Potential & Risks

RGR gets about 99% of its revenue from firearm sales. The continued growth of this company depends on political, social, and even international events and the election of Donald Trump was a tremendous boost to the industry.

With Mr. Trump in office, we believe the fight for further gun control will take a breather for at least the next four years. In fact, Trump has suggested a law requiring reciprocity on concealed carry permits. As stated before, we don’t see any future events that would cause mass gun purchases as seen in the last eight years, but we do see a stable market for firearms.

Concealed carry permits have grown over 150% in the last eight years. This trend will continue because there is a sense that violent crime is steadily increasing, thus more people are carrying firearms for protection. Both RGR and SWHC have noticed these trends and produce handguns just for concealed carry usage.

Also, Ruger has a strong relationship with the NRA, and that is extremely important in this industry. If you read our report on SWHC, you would see that an NRA boycott almost put them out of business.

Finally, during hard times quality and brand equity hold up. Being a top firearm manufacturer, the Ruger brand name will allow the company to endure through downturns better than most companies. The firm’s customers also tend to be very loyal.

Investment Risks

As we also pointed out with SWHC, there has to be a point in which there is a saturation of guns in the country. Since 1973, the number of households owning guns has dropped from 47% to 31% (Figure 4).

The Forward View

Forward View is initiating formal coverage of Sturm Ruger with a Hold rating and a $53 price target. Ultimately, we think the stock is fairly valued, and the best firearms stock is undeniably SWHC. From a relative valuation perspective, SWHC is cheaper by all of our favorite metrics.

We also believe that Smith and Wesson’s ongoing efforts to diversify its offerings and become an outdoor gear conglomerate creates a risk profile that will fall over time. Smith and Wesson is seemingly destined to be the small-cap version of Vista Outdoor (NYSE: VSTO). Meanwhile, Ruger will remain a pure-play gun manufacturer for the foreseeable future. Ruger’s fortunes shall remain tied to the firearms sector with no ability to cushion blows from a volatile industry. Smith and Wesson is working to develop the kind of flexibility that Ruger lacks.

Despite Ruger’s focus on gun manufacturing, the company’s margins actually trail those at Smith and Wesson. We attribute some of the differential to product mix and some to business efficiency. Figure 7 illustrates the two firms’ margins.

In summary, Sturm Ruger is a good business with a stock you don’t have a compelling reason to own. Only small-cap portfolio managers looking for a dividend-paying opportunity should even consider the shares. Around 40% of quarterly earnings are used for the dividend as the company’s management team doesn’t set a specific per-share payment.

 

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