Straight Shootin': The Truth About Ruger

| About: Sturm, Ruger (RGR)

Since Jan 2009 Sturm, Ruger & Co. Inc. (NYSE:RGR) is up 837%, for an annualized gain of 61%. These are amazing numbers, especially when compared to the S&P 500 which rose 93% during that same time frame. However, in the last 12 months, the stock hasn't done much. With a lot of fluctuation, it's up 24% YTD compared to the S&P's rise of 17%.

Since Jan 2009, RGR's growth of sales and income has been exceptional. Sales grew 167%, while earnings grew 715%, showing that the stock price growth is ahead of earnings. This rise in sales and earnings is due to the boom in gun sales that we've seen during the last few years. The National Shooting Sports Foundation [NSSF] Adjusted NICS report (see here) shows 8,993,964 adjusted background checks for firearms in 2008 alone. By 2012, that number had jumped to 13,780,285, an increase of 53%. The growth from 2011 to 2012 alone was 27%. However, there are some concerns that this growth may be slowing down, after all, guns have a long life, so unless people are building an army, sales will most likely not be able to continue at this pace. This may account for the sideways run the stock has been having lately. However, investors should keep in mind that slowing gun sales doesn't necessarily mean a contraction (think Fed. tapering). So long as there is continued growth in the market, RGR will be able to capitalize on that. It's just a matter of the rate of that growth and how long one can expect it to continue.

Another factor that should cause investors concern is that last year RGR decided to give a special dividend, causing their working capital to go from 3 to 1.78. While I am a big fan of dividends, I am an even bigger fan of manufacturing companies having a current ratio of at least 2 and preferably 2.5. If there is a slow down in gun sales, as analysts predict, the fact that RGR has less cash will only compound such a risk. RGR has no debt and, with a healthy current and quick ratio, investors didn't have to worry that there would be a need to borrow any money. But all that changed with the special dividend. No doubt the very same investors that were so happy to receive the dividend will be the very same investors who may not understand how such a company could suddenly be strapped for cash.

Furthermore, investors who did receive these dividends should be in an uproar over the fact that during the last 5 years, with all this growth and earnings, less than $8 million has been used to buy back shares. While the company paid out $111.5 million in 2012 in dividends, not one cent went to share buybacks. Why? Why would RGR decide not to invest in themselves, thus rewarding shareholders by making their shares more valuable without creating such great tax burdens on them. Again, I am all for dividends, I love them and would much rather see a dividend than many other things mangers decide to do with cash these days, but I like share buybacks just as much. If they had used even half of the $111.5 million to buy back some shares, I would have no complaint. It's the fact that they have put themselves in a risky position by lowering their cash, while not adding long term value to the shareholders that concerns me.

Valuation

The fact that RGR is trading at almost 8 times book value should not be a concern to investors. RGR's depreciation policy is to depreciate buildings over 15 years. This means that all of their facilities have been written off. According to their financial statements, RGR plans on spending $30 million on capital expenditures in 2013. If we assume that $20 million of that is for their new Mayodan, North Carolina facility, then we can get to a valuation for some of the other assets that have been fully depreciated.

The new facility is 220,000 square feet, which means that each square foot cost ~$91. According to their most recent 10-K, they have 2 facilities that they use, one which is leased. The owned facility (Newport, New Hampshire) is 350,000 sq. feet. If we give each sq. foot a value of just $75 (lower value then the new facility to be conservative), we would boost their assets by $26.25 million; which in turn adds approximately $1.36 to their tangible book value. With these additions of the New Hampshire facility to the tangible book value, we arrive at ~$8.36 which gives us a p/b of 6.5. This doesn't take into account the 25,000 sq. feet of corporate headquarters in Connecticut or their 45,000 sq. foot facility that they are currently not using. On top of this, there is the actual value of the real estate along with numerous other assets that can be re-valued.

While this still leaves the p/b ratio high, it demonstrates that there might be some more value that isn't on the books, which is why the current stock price might be justified.

Currently the P/E ratio for ttm earnings ($93 million) is about 12. This is a bit higher than I'd like to see, especially since I am worried about the long term growth of gun sales. If we use enterprise value, which is $980.23 million according to Yahoo! Finance, we get a multiple of 10.5x earnings. Even more telling is the multiple on the 5 yr. average earnings ($35 million), which equals 28. Although this high number is due to the rapid growth they've experienced, it still makes me nervous. Benjamin Graham ("The Intelligent Investor" ch. 5 "The Defensive Investor & Common Stocks") warns investors away from stocks that have a 7 yr. earning average multiple higher than 25; I try to find multiples of 20 on the 5 yr. avg. earnings.

Given the above paragraph, I don't think that RGR is a good investment at this time. I do, however, think it's a good stock to keep on your watchlist. Given the right price, I think this stock can make a good long-term investment opportunity.

Disclosure: I 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.