The National Instant Background Check System (NICS), managed by the FBI, is considered as the most reliable proxy for monthly firearm sales. In 2015, the FBI processed an all-time record of 23 million checks.
Since 1998, two of the highest weeks for NICS checks were in January and February 2016, respectively ranked 9th and 7th. Background checks have increased by 25% in March 2016, compared with the 2015 figures. It was the 5th highest monthly record since NICS' inception, leading the industry to a potential new record this year (the graph below shows monthly background checks).
The growing American interest for gun purchases has been mainly driven by recent terrorist attacks in Paris in November and San Bernardino in December. The Obama administration's will to expand background checks and gun control in general have also been key drivers for firearms sales expansion. This upward trend is not likely going to struggle by the end of the year. According to Real Clear Politics, polls show that the future Democrat candidate has the most chances to win the presidential race. Both Hillary Clinton and Bernie Sanders are in favor of broader gun control policies. If consumers expect new regulations limiting access to firearms, they are going to stock up products, thus increasing future expected revenues for Sturm, Ruger & Co. (NYSE:RGR).
The executive officers of the company are all experienced professionals and very enthusiast about their business. The chief operating officer, Christopher J. Killoy, has a military background. He graduated from the U.S Military Academy in 1981 and worked for Stinger System Inc., a manufacturer of non-lethal weapons for law enforcement. Michael O. Fifer, the chief executive officer, graduated from the Naval Academy in 1978 and served as a submarine officer. He previously worked for Watts Water Technologies Inc. (NYSE:WTS), where he was able to turn inefficient business units into profitable divisions. Under his management, Ruger's stock has risen from $7 to $65, which is an increase of 779% in 10 years. Today, Ruger employs 1920 people across the U.S, and it has achieved to develop high commitment from its employees. For instance, there is no turnover among the engineering staff of 140 employees, creating value through designing and manufacturing expertise.
Historically, Ruger's firearms sales have represented 99% of the revenue, and the casting activity has accounted for the remaining 1%. Its biggest advantage lies in its distribution channels. Even if it still sells directly to end customers, the company has achieved to limit costs and gain in efficiency by selecting a network of twenty independent and federally licensed wholesalers who resell the entire line of products to independent retailers for the commercial market, twenty-four for the law enforcement market and two for the Canadian market. The five largest customers have accounted for 57% of total sales in the last three years, which has allowed Ruger to limit the number of employee dedicated to customer service to fifteen.
Regarding production, the company has at its disposal four manufacturing facilities: Newport, New Hampshire (350,000 square feet owned), Prescott, Arizona (230,000 square feet leased), Mayodan, North Carolina (220,000 square feet owned, not fully operational) and Earth City, Missouri (35,000 square feet leased). Three other non-production facilities exist in Southport and Enfield (Connecticut) and one building of the Newport plant. Ruger does not have any debt-related expenses regarding its owned facilities, enhancing the ability of the company to adapt to new market environment if necessary.
Sturm, Ruger & Co. is evolving in a very competitive market. Since product differentiation is difficult to achieve in the firearms industry, brand recognition is a predominant aspect in the company's strategy, as well as managing value creation, efficiency and margins.
Table 1 shows that Ruger outperforms its main competitors in firearms production, Smith & Wesson (NASDAQ:SWHC) and Vista Outdoors (NYSE:VSTO), on a lot of different levels. Value creation is more important for Ruger, with a ROIC to WACC ratio of 6.16 historically, as compared to the industry's 1.87. In the last fiscal year, the company created as much as twice more value than its competitors. WACC has stayed at 9.0% mainly because Ruger has achieved its growth without taking any debt. In addition, its engineers and designers have been able to create new products on short cycle of one to three years. These new products - less than two years old - have driven growth and represented $115.4 million (21%) of 2015 sales and $89.4 million (16%) in 2014. Consequently, EBITA is at 19.2% historically and 17.2% in the last fiscal year, against 11.4% and 14.0% for SWHC and VSTO, respectively. Inventory levels decreased by 16,800 units, from 430,900 in 2014 to 358,400 in 2015, driven by a strong demand in the fourth quarter of 2015. The strong demand drove shortage for particular new products, such as the Precision Rifle. The company is deploying strong efforts to ensure that wholesalers and retailers keep more products in their inventories during the summer to avoid any inconvenience to customers. As a result, and because of the political and security environment, it is reasonable to expect further growth in revenues in the coming year. Ruger's revenues increased by 1.2% in 2015, while Smith & Wesson's decreased by 11.9%. Historically, Sturm, Ruger & Co. has also beaten revenue expectations by 5.93% and adjusted earnings per share consensus by 36.21%.
Moreover, Ruger is more efficient when it comes to capital management. Its capital usage ratio (revenues/invested capital without goodwill) was at 3.0 in the last fiscal year and at 5.30 historically, compared to 2.0 and 4.19 for competitors. The cost of goods sold to revenue is also better on both horizons.
As the table above shows, the company has achieved to reduce its general and administrative expenses over the years. We can observe a slight increase in 2015 that is due to a new summer marketing campaign that did not exist before. At the same time, management planned to decrease capital expenditures from the $28.7 million level in 2015 to $25 million in 2016. For the valuation process, all these elements led to adjusting operating expenses to revenues forecast in the continuing period to analyst forecasts at 71%.
Furthermore, Ruger is historically less risky than its competitors, with a 5-year unlevered beta of 0.33 against 0.84 for the industry. It also have a lot of cash on hand, with $69.2 million available at the end of 2015 compared to 42.2 million for Smith & Wesson, allowing management to enjoy freedom of action regarding the future of the company. It could easily decide to invest in new facilities or research & development, to repurchase shares or to provide shareholders with a special dividend.
The compound annual growth rate of free cash flow margin, at 24.10% over the last five years, proves the financial efficiency of the company.
Finally, unlike Smith & Wesson and Vista Outdoors, Ruger distributes dividends and has a clear policy about them. It redistributes approximately 40% of the net income to shareholders every quarter for a twelve-month dividend yield of 1.80% and a five-year dividend growth of 31.87%.
According to a Gallup poll released in last December, Americans listed terrorism as their first concern regarding their country's future. Paired up with the presidential election, Sturm, Ruger & Co. is currently experiencing a strong momentum for sales growth. Management proved its abilities to efficiently run and expand the company's operations, both industrially and financially. Thanks to the large amount of cash on hand and zero debt, the company has still a lot of leverage to adapt to the future prospects of the market. All these elements makes Ruger the best in-class investment within a one-year investment horizon, and have led my valuation process to set the one-year target price at $69.00.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RGR over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.