By Jason Born, CFA
In politics, like investing, we often find that the animal spirits which Keynes discussed may take control for extended periods of time. Up until very recently Sturm, Ruger & Company (RGR), the celebrated firearms maker saw fantastic growth in the price of its stock, rising from around $22 in the summer of 2011 to just above $58 this spring. Much of this can be attributed to the increased interest in outdoor sporting activities such as hunting and shooting. But simultaneous to that shifting demand curve, is the real or perceived concern - said animal spirits - from some U.S.-based citizens that gun rights will be curtailed by the current administration. A good case can be made that this latter belief is driving fundamentals at RGR and other gun related companies by pointing to the 50% revenue increase for RGR from '08 to '09 and then the jump thereafter. And lest the reader think that 2008 revenues were depressed due to the global recession, they were not. In fact, revenues for '08 were 16% higher than 2007 revenues.
That is all well and good, but, "Where," you may ask, "are we going with this discussion?" Will this be another article talking about the fantastical growth of RGR and how we should buy it today, before the specter of government rushes in to prevent future purchases? Not exactly. We plan to look at the lesser-known, perhaps fairer priced, Olin Corporation (OLN) to see if we can divine whether there is any hidden value currently escaping the highly analytical minds of the mad crowds of stock investors. Is there any hope of the animal spirits taking hold and driving its price upward as well?
Olin is tiny when compared to its peer group of commodity chemicals makers (Dow Chemical (DOW) & Occidental Chemical, a part of Occidental Petroleum (OXY). In 2011 71% of its revenues came from producing chlor-alkali chemicals. We are certain that unless you've had a refresher chemistry class in the past year, our description didn't help your understanding at all. Suffice it to say, that those chemicals are then sold downstream to other manufacturers to make PVC and bleach, process pulp and paper, and purify water. The other 29% of the company's revenues, that is, the interesting 29% of revenues, are of sporting and military ammunition sales under the famous Winchester brand name where they compete with Remington Arms Company and Alliant Techsystems, Inc. (ATK).
Since its latest restructuring in 2007, OLN has produced average revenue growth of 11% annually, mostly due to the modest global economic recovery generating higher chemical sales. The chemical business is highly cyclical. For the coming years, we assumed an unexceptional 2% global growth rate to modestly propel the chemical segment's sales.
Perusing several of their 10-k filings for recent years, we find that Olin noted a sharp increase in ammunition sales at the time of the 2008 fall election. That revenue increase has averaged 9% annually since then. Winchester segment earnings have increased even more than revenues due to efficiencies and margins are expected to widen further with additional cost-saving measures currently being employed by the company. Earnings per share for the company as a whole have averaged $1.90 for the past several years. We expect earnings per share to average approximately $2.10 for the coming three years (forecasting an average earnings number should remove some of the inherent instability in trying to navigate quarterly and annual forecasts).
We never want to ignore the balance sheet which can be a company's saving grace in times of turmoil. OLN's balance sheet looks solid. They carry a manageable debt load that is 34% of total capital. Most of the debt is not due for more than five years and they have roughly $230 million of borrowing capacity left on a relatively unused revolving line of credit. Working capital per share is nearly $5 and the current ratio is 2. All this is to say that the company has liquidity should sales ever drop due to unforeseen events.
Buying the stock today will get you a 3.9% yield which we deem safe given the balance sheet cushion. The dividend payout ratio is elevated, averaging about 50% over the past several years, so a prolonged downturn in sales or earnings could mean a potential cut. They have paid dividends totaling $0.80 per share annually for many years. Management does have an incentive to support the dividend and stock price as they own close to 4% of the company.
Heretofore, despite the fundamental improvements of the company and despite the exposure to a potentially fashionable ammunition segment, the political and market animal spirits have not taken over. We believe the company's share price has a fair value of $23 to $26. As we respect the frightening power of incorrect projections, we have used very conservative benchmark multiples of 1.8 P/B and 12.5 P/E to come up with our estimates of value. Should the current administration win their re-election bid, our expectation is to see another jolt upward to OLN's ammunition sales. We did not include this jump in our price forecasts.
So it depends upon you, the investor, as to what you demand from taking the risk by investing in stocks. The recent price of $20 for OLN is below our estimate of fair value. Certainly, most risk-averse investors would be comfortable making a purchase of the stock if it were to fall below the $20 mark to ensure a large margin-of-safety, but those of you intrepid enough to go ahead even today, may find a 15% to 30% return in addition to a safe dividend. Let the animal spirits run.