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Summary

  • Sturm, Ruger & Co operates a growing firearms business.
  • The company has a very strong balance sheet with no long-term liabilities.
  • The shares are relatively cheap from a historic perspective.
  • Repurchasing shares will create value for the shareholders.
  • Sturm, Ruger & Co should announce a share repurchase program.

One of the tools for a public company to create value for the shareholders is to repurchase own shares in the open market. For a public company to create value for its shareholders, timing the repurchases is crucial. I find that Sturm, Ruger & Co (RGR) is the perfect candidate to start repurchasing own shares in the near future. Therefore, among other reasons, I added this company to my portfolio this week. In this article, I will argue why Sturm, Ruger & Co is the perfect candidate to create value for the shareholders through the introduction of a share buyback program.

Firearms business

First of all, Sturm, Ruger & Co operates a growing firearms business. For example, the company was able to grow cash provided by operating activities to $120 million in 2013 from $32.5 million in 2010 (an increase of 269%). To support growth, Sturm, Ruger & Co had to invest as well. Investments in property, plants and equipment amounted $54.6 million in 2013, up from $19.4 million in 2010 (an increase of 181%). Overall, the company's free cash free increased almost 400% to $65.1 million in 2013, up from $13.1 million in 2010. The data is presented in the graphic below.

Last week, Smith & Wesson Holding Corporation (SWHC), Sturm, Ruger & Co's most important competitor, released a disappointing guidance for their fiscal year of 2015. Following the announcement, shares of both Smith & Wesson Company and Sturm, Ruger & Co fell sharply. The market is concerned that the firearms business will not grow as fast as it did in the past four years. In my opinion, it is likely that the firearms market will not grow as fast as it did in the past years. Therefore, Sturm, Ruger & Co should consider alternative ways to create value for the shareholders. For example, the introduction of a large share buyback program.

Shareholder value

Introducing a share buyback program will not by definition create value for the shareholders. In my opinion, there are two important factors that matter: the amount of debt used for repurchasing shares and the valuation of the company. In this article about Apple (NASDAQ:AAPL), I argued that companies can create shareholder value through introducing share buyback programs. In fact, Apple is a perfect example of a company that creates value for its shareholders through the introduction of a share buyback program.

Apple raised its buyback authorization by $30 billion to $90 billion on April 24, 2014 (see this article). Later, Apple announced the pricing of a $12 billion debt offering to finance the capital returns. In accordance with my arguments, the use of debt to finance share repurchases creates value for the shareholders, because interest is a tax-deductible expense. Further, Apple's management proved that it times the share repurchases perfectly. In February, Apple's CEO Tim Cook stated in this interview in the Wall Street Journal that the company repurchased $14 billion of its own shares. Since, Apple's shares surged almost 25%.

Another good example is Smith & Wesson. Smith & Wesson announced a debt exchange and a $100 million buyback program on June 13, 2013 (see this press release). Under the buyback program, Smith & Wesson purchased 9.0 million shares of its common stock or 13.9% of the total number of common 13.9% of the total number of common stock outstanding (see this press release). Since the announcement of the program last year, Smith & Wesson's shares surged 68% versus a 30% increase for Sturm, Ruger & Co's shares (see graph below).

Source: Yahoo! Finance

Sturm, Ruger & Co's potential

Like Apple and Smith & Wesson, Sturm, Ruger & Co has a very strong balance sheet. According to the company's first quarter results, Sturm, Ruger & Co has no long-term liabilities, $96 million short-term liabilities and $193 million equity. Like the examples of Smith & Wesson and Apple, I suggest that the company announces a debt offering together with the announcement of the buyback program. Since interest is a tax-deductible expense, the combined announcement will create value for the shareholders immediately.

Further, Sturm, Ruger & Co's shares have been under some pressure lately. As a result, the company's forward PE Ratio dropped below 13 and its price to book value dropped below 6 for the first time (see graph below). Compared to Smith & Wesson, it is fair to say that there is not much of a difference between the current valuation of the two companies. Therefore, Sturm, Ruger & Co's current valuation does not preclude the introduction of a share buyback program.

RGR PE Ratio (Forward) Chart

Conclusion

Overall, I believe that Sturm, Ruger & Co has a great opportunity to start repurchasing own shares. The company's balance sheet is strong and its valuation does not preclude the introduction of a share buyback program. If Sturm, Ruger & Co follows the examples of Smith & Wesson and Apple, that is the offering of debt to finance the buyback program, the company creates value for the shareholders. Therefore, I would be more than pleased if the company decides to start repurchasing their own shares in the near future.

As a final note, this article only represents my own opinion regarding the potential of Sturm, Ruger & Co's value. Obviously, it is not certain that the company will introduce a share buyback program next to its attractive dividend (yield: 3.20%).

Disclosure: The author is long RGR, AAPL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Sturm, Ruger & Co.: My Number 1 Share Buyback Candidate