You Would Have To Shoot Me To Buy Sturm, Ruger & Co At Today's Price

Aug.21.14 | About: Sturm, Ruger (RGR)

Summary

Insider activity in the past two years is extremely bearish given the unprecedented rise in stock price over the past five years.

Recent statement about the expansion of stock buyback program implies that the intrinsic value is far below current price.

Demand, and therefore, stock's valuation are extremely volatile due to the people's sensitivity to potential banning of guns and elimination of 2nd Amendment rights.

Lack of economic moat and increase in new entrants and industry capacity will drive down profit margins in the long run.

A friend recently asked me if I would invest in Sturm, Ruger & Co (NYSE:RGR). As a value investor, I tend to look for companies trading near their intrinsic value and operating with some form of competitive advantage, conferring long-term economic moat. This company fails to deliver on both of these fronts.

Intrinsic Value

One way to determine the intrinsic value is knowing when management would trigger a stock buyback. Recently, Ruger announced the expansion of its buyback program from $25 to $100 million. According to the Q2 earnings transcript, Ruger will only execute the program if the price drops below the average of historical earnings multiple. CEO Fifer stated:

Stock repurchase authorization, yesterday the Board of Directors expanded this authorization to repurchase shares of common stock from $25 million to $100 million. It is important to note that raising the repurchase authorization to $100 million does not mean we are committed to buying $100 million of stock. We believe that the market should set the price of the stock and if it is trading in the range of its average historical earnings multiples than the company should sit on the sideline.

Shareholders interest in purchasing stock should not have to compete with the company to acquire more shares. But if the stock price drops below the average of historical earnings multiple then it is appropriate for the company to step in and opportunistically repurchase shares. The key is to create value for current and future shareholders too and not just for the existing shareholders. Those are the highlights of the second quarter.

Besides determining the right historical average PE, the biggest question is what the future earnings will be if you strip out the effects of politics around gun control.

Sad to say, but negative news (another public shooting prompting debate on potential gun control and elimination of 2nd Amendment rights) drives demand. Given the demand spike for the past 5 to 7 years were mostly events driven, and the recent tapering in demand in the past two quarters (see Volte-Face Investments' article), we may be seeing the beginning of reversion. There is a lot of diehard fans and loyal supporters for this company; thus, the reversion may take some time to play out.

Historical PE:

Lowest was in 2008 with P/E of ~4.8. Highest P/E was 2006 when price reached $10.56 that year with EPS of $0.04. But overall, the past 10 years' (annualized) high was 19.8 and low was 8.7.

With the stock trading currently around 10 PE, it's hard to believe that management will exercise the buyback program given the past 10 year of PE numbers (i.e. average PE over that time period is likely higher than 10). Moreover, in the past two years, the executives started selling when the price was $45 and all the way up to $75. I doubt they would initiate a buy themselves or with the company's money if you take Fifer's statement seriously. From this, I judge that the stock price is still over-valued even at 10 PE.

If you believe after stripping out event-driven or politically-driven demands, the earnings will revert close to its historic level (maybe a bit higher if you believe in new demand from women and general population growth). This type of reversion happened back in the 90's, and will happen again over the long run.

My take on valuation:

The EPS was between $0.03 to $0.16 in 2004-2006 and $0.46 to $0.43 in 2007 and 2008. Based on these earnings, the current price of $50 implies a PE >> 100. In other words, the current PE of 10 implies a price of $5. This may be too low given the new demand from women getting into the sport. However, it's a far cry from the current price of $50. New entrants from competition will also put pricing pressure on RGR and may offset some of the growth in new demand.

Net net, I see a bubble bursting short of artificial support from further negative events (i.e. another senseless public shooting prompting more debate on gun control laws). As a value investor, I would not touch this stock given the unpredictable future demand and lack of economic moat. However, if you hold a gun to my head (no pun intended), I would probably initiate a buy at $20. As a momentum trader, I would wait for the next round of event induced spike and short the stock when it reaches $80+.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.