Guns And Butter For The Investor

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 |  Includes: GD, LMT, RGR, SWHC
by: Dr. Harold Goldmeier

Summary

There is plenty of war and conflict around the world, and instability in cities, to support increasing demand for production and sale of arms and ammunition and investors making money.

M & A have created an oligopoly, especially in small weapons, but there are opportunities for investment growth for those willing to take risks or investors wanting safer shelters.

It might be wise to wait for dips in stock prices of some U.S. weapons producers, while investigating opportunities in foreign companies.

This is not a primer on death and the best killing machines. It is brief comment on investment purposes in defense companies, small weapons, and ammunition manufacturers. The latter produce guns and rifles, ammunition, and smaller military arms. Their products are for personal defense, recreational use, hunting and sports shooting, and small arms for military sale.

Defense companies comprise what President Eisenhower sagaciously tagged "the military-industrial complex": aerospace and missiles, military vehicles, clothing and protective gear, ships, mercenary companies, biotech, and electronic or computer systems. Eisenhower was prophetic when he foresaw it as a "complex."

Estimating the size of the arms industry is fruitless. Much is secreted, concealed, and purposely mislabeled. Disinformation is their marketing tool of choice. Suffice to say military expenditures ($1747b) alone annually account for 2.4% of the world GDP or higher. Here's a link to more information about the 100 largest arms producers and military services companies. 7 out of the top ten are USA firms excluding China. China shares little if any reliable information about its arms industry.

My favorite defense contractors make what militaries desire, order, and reorder: General Dynamics (NYSE:GD) has $30b in sales, 7.4% net profit margin. GD has a progressive R&D, and is heavy into development of pilotless drones offering a bright sales future (known as the GDRS program). Lockheed Martin (NYSE:LMT) makes the workhorse C-130 airplane, a military staple. Though sales are down this past year by 4% for the company, income growth is at 7.5%, and the dividend yield at 5%. Both stocks are at their 52-weeks highs, but deserve a close eye for future investment on a dip in price. Both are highly rated worth holding or buying.

Mergers and acquisitions since the 1990s created an oligopoly in the small arms trade industry. Smith & Wesson Holding Corp. (NASDAQ:SWHC) and Sturm, Ruger (NYSE:RGR) have each attracted at least seven analyses on Seeking Alpha in June and August of this year. A 2013 analysis of the small arms industry notes the two companies "have consistently held the number 1 and 2 ranks for (the past) 25 years."

Standard basic classification of arms into small arms or light weapons

Small arms Light weapons

Revolvers & self-loading Heavy machine guns and anti-materiel rifles pistols (12.7-20 mm)

Rifles & carbines Hand-held, under-barrel & mounted grenade launchers

Assault rifles Portable anti-tank guns

Sub-machine guns Portable anti-aircraft guns

Light machine guns Recoilless rifles

Portable launchers of anti-tank missiles & rocket systems

Portable launchers of anti-aircraft missile systems

Mortars of calibres less than 120 mm

If an investor has the smarts and guts to trade on an overseas exchange, Forjas Taurus SA (Sao Paolo: FJTA4.SA) is an interesting company. It enjoys a buy rating from analysts, but they are not identified. Taurus has a market cap of 131m Brazilian Real (1R to .44USD). Shares trade currently at R.58 down from a 52-weeks high of R2.45. Before investing, order and read the Reuters Research Report on the company's performance, position, and cash flows for the past three years.

It is a Brazilian based producer of small weapons: revolvers, pistols, ammunition, and other metal works including motorcycle parts, construction tools, and plastic injected molding products. Between 2010 through 2014, Taurus took on long-term debt to grow business.

With 5,000 employees, and annual revenues of R746m, Taurus lost nearly R1m in net income last year. They are in business since 1939. Taurus has five plants in Brazil and one in the U.S. the Bank of Brasil holds 21.35% of the shares, and 12.58% are held by equity funds and investment houses. In May 2014, Companhia Brasileira de Cartuchos (CBC) increased its holdings from 2% to nearly 17%. Management hints there might be future merger talks, because "it sees significant synergies between the two companies." Taurus share price is down 46%. Investigators are examining the company's Chairman for his role in the sale of a factory, insider trading, and reported company financial losses.

Another small arms producer worth watching is IMI. Israel's government in 2013 and Finance Committee approved in 2014 privatizing Israel Military Industries Ltd. (IMI). Applications and bid forms are available. Once IMI is sold, the owners will undoubtedly take it public. The company manufactures firearms, ammunition, and military technology sold in Israel and worldwide. Its inventory includes brand names UZI submachine gun, Galil and Tavor assault rifles, the Negev light machine gun, and the Jericho pistol. IMI redesigned the Magnum semi-automatic pistol for its American manufacturer. It is one of the most sophisticated research and development companies in small weapons development.

Here is why the government is selling off IMI. The company lost NIS593m (about US$175m) in 2013 for the 14th straight year, and double of 2012. This loss comes despite an operating profit NIS1.4b, and a revenue increase of NIS24.7b. IMI sales are about NIS2b with the backlog of orders reportedly amounting to more than NIS5b. 70% of sales are for export. IMI losses are largely due to excess employees (estimated to be 30%), and out of control pension fund obligations. Sounds like the US auto industry pre-2007.

Some people are skittish about the growth potential of the weapons and ammunition business. The U. S. military exit from two Middle East wars is a sign of returning to a position of military isolationism.

Sales blips for ammunition manufacturers Olin Corp. (NYSE:OLN) may be signs of temporary demand from fear of new stringent gun control laws, changing winds on the political scene, and social upheaval. Inventory shortages plague the industry for several years. Blips are not indicators of healthy long-term growth trends.

On the other hand, civil wars are raging in the Middle East. Demand for guns and ammunition remains strong in Mexico, South and Latin America. Riots and armed gangs in U. S. cities spur civilians to arm themselves with pistols and rifles. The warnings from the U. S. Secretary of Defense, CIA, and British intelligence, that ISIS terrorists will soon be returning home to the U. S. and U.K., feed the frenzy of survivalists arming themselves for the day.

OLN sales grew in the last 52 weeks by 15% and income by nearly 20%. The dividend yield is near to 3%. Its Winchester ammunition brand accounts for a lot of the sales growth. Olin, like nearly all arms and ammunition manufacturers, make other products rounding out the companies' portfolios. An investor has to weigh the sum of the parts to the future of the whole.

Never underestimate the human desire to own guns. Mark Twain called his Smith & Wesson's seven shooter "grand." Guns are not a fad. They are staple of war, revolution, criminal activity, self-protection, and they provide psychological gratification. That's why the industry will enjoy stability and growth.

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.