The recent tragedy in Tucson involving Rep. Gabrielle Giffords once again puts the spotlight on the firearms industry. Gun control legislation often is implemented after a tragedy like this, and now is a good time to look at the likelihood of limitations being placed on a company like Sturm, Ruger & Co. (NYSE:RGR).
I won’t re-hash the history of Sturm, Ruger because there is another excellent article on Seeking Alpha going into detail about the founding of the company, the leadership under Bill Ruger, and the progression through today. After reading this article, I encourage you to take a moment to read: "Sturm, Ruger & Company: The Apple Inc. of the Firearms Industry."
Sturm, Ruger designs, manufactures, and sells firearms in the United States. In fact, they’re the only full-line American manufacturer left. They have more than 400 products in four product categories: single-shot sporting rifles, shotguns, pistols, and single action and double action revolvers. They sell their firearms through select distributors.
2009 saw significant revenue growth for the company due to the fear that President Obama and a Democratic Congress would enact further gun control laws. That fear was overblown, but it led to revenue of $271 million in 2009 compared to $181 million the previous year. There was concern among investors that 2009 would be a one-off year, but through the first nine months of 2010, revenue is already at $191 million, and it’s expected to be more than $230 for the full year. A drop-off, yes, but also possibly a new normal over previous years.
The shooting in Tucson may affect Q1 2011 sales, although we won’t know this for many months. Google (NASDAQ:GOOG) searches for gun sales skyrocketed after the shooting as many were afraid it would lead to more gun control laws. Just as this didn’t happen in 2009, it doesn’t appear that there is enough willpower to enact stricter laws this year either. With the House of Representatives controlled by Republicans, I would be very surprised if anything gets to the president’s desk.
That being said, there will undoubtedly be some debate on the subject, especially as Rep. Giffords’ condition improves. This debate in and of itself may spur some citizens to make gun purchases, potentially benefiting Sturm, Ruger. The irony is that gun sales increase as gun control is more publicly discussed. At the state level, I also don’t expect many additional laws to be passed in the near term.
Moving on to Sturm, Ruger specifically, they have an excellent reputation and were named as one of the top 100 best small companies in America by Forbes magazine last November. They’ve also won numerous awards including the National Association of Wholesalers’ “Retailer of the Year” award multiple times. CEO Michael Fifer seems to be doing a tremendous job.
Cash is rapidly accumulating on Sturm, Ruger’s balance sheet and they’ve put it to use in a shareholder-friendly way. Over the first nine months of 2010 they bought back $5.7 million worth of shares, representing 2.1% of outstanding shares. They’re authorized to buy back an additional $4.3 million shares. They’ve still got $53 million in cash and investments on their books, and no debt, and they’re generating upwards of $30 million of free cash each year.
Before 2003 their dividend was $0.80/share. It's currently $0.31, giving them a 2.1% yield. If management feels as if they have some visibility on the sustainability of this higher revenue, I believe it’s likely they would increase their dividend substantially or increase their buyback substantially. Much of this depends on how Q4 2010 goes.
In terms of valuation, it’s difficult to get too exact. If you assume the share buybacks in place will reduce the count by another 2.5% and you take the last four quarter’s EPS of $1.46, slap a P/E of 10 on it, then you get a price around $15, which is what it’s currently trading at. Two things on that, though: The historical P/E has been in the high teens, and it may be better to give a multiple of EBITDA instead. A 17 P/E would give you about $25, or a 6 multiple on estimated 2010 EBITDA would give you something around $19. Given the uncertainty of whether this higher revenue will be a new normal or not, I’m going to peg the stock price range between $15 and $25. Hopefully we’ll know more after Q4 earnings are reported, but it appears 25% undervalued at today's levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.