Is Aiming For Alpha With Ammunition Stocks Off Target?

Includes: AOBC, OA, OLN, RGR
by: Davin Research

A previous article of ours has already established the advantages of being invested in firearm stocks such as Ruger (NYSE:RGR) and Smith & Wesson Holding Company (SWHC); this article will cover the potential profitability of being invested in ammunition stocks as well, including Olin (NYSE:OLN) and Alliant Tech Systems (ATK). Like what we have seen with desired firearms in short supply, a similar phenomenon has been seen with ammunition; popular calibers such as 9 mm and .223 are being bought up by American citizens to such a degree that not only are there supply problems in the USA, but even in Australia. A similar problem exists in Canada. Before beginning this article, I went to three Alberta gun stores and saw both shortages of common calibers, and prices around 20% higher than last year. In our following discussion, financial information is taken from MSN Money.

ATK and OLN both sell ammunition to the civilian and professional markets. For OLN this is under the Winchester brand. However, it does not solely deal in this market; it also has chlor-alkali and chemical distribution divisions. ATK is also diversified beyond ammunition, operating in both aerospace and defense markets. For OLN, ammunition makes up 28% of sales and 16% of 2012 profits. In the case of ATK, these numbers are 26% and 22% respectively.

Currently, OLN yields 3.3% after appreciating 18% in the past year, where as ATK yields 1.3% after appreciating 58% over the same time period.

When the gross profit margins of both companies are considered, ATK has been more consistent at around 21% over the past five years, with OLN similar at 19 to 20% with the exception of in 2010 when margins dropped to only 15%. When the selling, general, and administrative expenses of both companies are compared, ATK has been constant at 40 to 43% of gross profit going towards these expenses. OLN has been a bit more erratic spending 35% of gross profit in 2008 on SGA expenses; this increased to 57% in 2010, and decreased back to 38% in 2012. It is worthwhile to note that the SGA expenses for OLN did not increase in 2010; 2010 showed a decline in gross profit.

When the net earnings of both companies are compared, neither show a distinct trend. From 2008 to 2009 OLN's net earnings decreased 14%, followed by a 52% decrease the next year. From 2010 to 2011, net earnings increased 272% followed by a 38% decrease the next year. ATK possesses similarly erratic net earnings trends of 10% increase in 2008 - 2009, and 12% increase, 16% decrease and 3% increase in the following years. Just as troubling is the net earnings as a percent of revenue over the past five years; for ATK this ranges from only 3 to 6%, and OLN 4 to 12%. Since 2008 OLN has decreased its assets to liabilities ratio from 1.7 to 1.6 and in the same time ATK has increased theirs from 1.2 to 1.5. Both companies also have significant long term debt.

Now compared to RGR and SWHC in a recent article, how do the gun companies stack up against the ammo companies? There is no doubt in our minds, we sleep soundly with RGR in our portfolio (and in our gun safes! ) due to the far higher margins, (for RGR up to 14% net earnings as a percent of profit) which for Warren Buffet is a defining factor, as well as the more consistent positive financial trends of the firearm companies. Of course investors will need to do their own research, but our play on the current demand for arms and ammunition lies in RGR (or SWHC) but not OLN or ATK.

Disclosure: I am long RGR. 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.

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