A few days after my last article on Smith & Wesson, Inc. (SWHC) I began wondering if more research was needed to support, or ruin, my thesis on Smith and Sturm Ruger (NYSE:RGR) and firearm demand. I debated whether it was worth the time to look up the detailed numbers on sales and try to track what is happening more closely. After all, what if I am wrong? Has my money been in the wrong place, and have I advised others on an incorrect thesis? The market has declared so far that I am wrong.
So, I decided to dig a little and run the numbers for NICS checks to see if I was missing something. After all, I have been saying that the market analysts were wrong as proved here and here, amongst numerous other places. Here is the quote that had me wondering enough to look into the boring research into NICS numbers - research that nobody else seems to be doing?
James Debney, CEO "Higher revenue on our Firearm segment was driven by strong orders for our concealed carry handguns, and modern sporting rifles."
This quote is hardly the shocker if you have read any of my most recent firearm manufacturer articles. However, this nagging feeling that I didn't know the exact numbers and was only going with NICS numbers, market ads and popular items seemed to be. Wanting to know for sure, I decided to dig even deeper than I had before and observe the numbers for all NICS checks by type to see what they actually told us in more detail.
Before going too far into the numbers, it's important to note that NICS checks are not a perfect illustration of firearm demand. They are, however, the only thing we really have. I believe the data on background checks can be used as a proxy to show us rough estimates on what is happening and from that estimate, we can choose a course of action.
If you are not willing to read on, here is the short of it... the manufacturers themselves have told us this already!
What part of NICS checks has the market missed?
Nothing spectacular, right? This is the same chart we have been looking at for a while. It has lower numbers to the top and left and higher to the bottom and right. Just what you would want to see if you were a shareholder in Smith or Ruger. However, looking at the NICS checks by type of firearm is where Mr. Debney's quote led me. The FBI tracks this information and puts it in PDF files just like the overall numbers. (The overall number is the headline that everyone has been reading, and many "analysts" are not even getting that right!?)
The data I compiled is from the NICS background checks, but it is the data sorted by state and type of firearm. This is where our key trend can be found and where we have more than enough data to suggest a course of action... if we like facts.
The above link shows a monthly tally of how many background checks were done, but sorted by state and type. While I find state-to-state preferences interesting, the compilation of overall type is what I was curious about. The types are broken down by the FBI into only three real categories. Those categories are handgun, long gun, and "other." The other category is where we find items that are not easy to classify. (The most common item in "other" is the stripped lower receiver.)
In the simplest way I could explain to a non-firearm user... a stripped lower receiver (or times just called a lower) is the portion of a firearm just about everything else revolves around. It is the relatively small metal part that will be where the trigger, barrel, stock, and selector all come together to create a unique firearm. (There is a little more to it, but that's the easiest way I can think to explain it.)
This stripped lower can be made into numerous different devices that could eventually fire a bullet. The reason the FBI marks lowers as "other" is that technically this part can be used to create a long rifle, a shortened barrel rifle, or even a pistol variant. So it can fit in either category. However, they are most likely going to become MSRs that are built by enthusiasts, and customized to their liking. (This is also the portion that contains the serial number.)
The Complete NICS data
I created a simple graph showing the numbers of overall background checks, and added the categories that are also tracked by the FBI. (Again, those categories are handgun, long gun, and "other".) In every area, I rounded down to the nearest 100. Each month has a data point back to 2010, which seemed a far enough location to find trends.
Below is what the data worked out to be:
And here is the simple graph showing NICS checks only by type and with a simple trend line added:
These are only the facts... no spin. There are no opinions and no feelings in these numbers. What the data shows is that handgun and "other" are growing rapidly. (And again, the "other" category is mostly MSRs that people will build themselves.) In fact, handgun purchases overtook long gun purchases in 2015 and have not appeared to let up. This favoritism of handguns over long guns is not something new, but something we can see all the way back in 2010.
What the data shows
The data shows that handguns are becoming far more popular and have become the largest category of firearm purchased. After the tragedies and subsequent surge in 2013 pulled forward sales, firearm purchases dropped off. Once demand started to return to its normal trend lines, we can clearly see that, in 2015, demand for handguns continued to climb and overtook the storied long gun category.
I have many thoughts as to why this happened, but none of them matter to the intent of this article. I merely want to show the data and what has happened to date with firearm sales. The information in these graphs shows that Ruger and Smith's main products are centered at the sweet spot for sales in the firearm market. While Vista Outdoor (NYSE:VSTO) is doing well providing the consumable ammunition for all of these devices, when it comes to firearm manufacturing, it makes only rifles and shotguns which fit into the long gun category. (It's worth mentioning that the long gun category is growing again - after the 2013-2014 post-surge drop in demand, however, they are not growing as fast as the handgun market.)
The data we don't have yet
The December numbers will most likely show us if we have a new trend line. This is a key month for firearm manufacturers and this is why I believe we are less than two weeks away from seeing whether analysts are pushing an ideology or actually trying to present facts.
December numbers are more important simply because it appears we had a surge in sales before the election. (Smith bigwigs even mentioned it in the analyst call.) NICS numbers are reported monthly so we usually don't have any color on when purchasing happened, whether early or late in the month. November did have one day that we are lucky enough to see is reported separately and that is Black Friday. This is our one hint at whether demand is still high.
Black Friday NICS checks were above elevated 2015 numbers at 185,715 background inquiries for November 25th, 2016. That shows us that demand, at least on Black Friday, was high even after the election results were known. It is conceivable that early month checks ran incredibly high and tapered off, save for Black Friday. Hence, only December numbers can really tell us if demand is remaining high after the election results are known.
Why December numbers matter so much
It is widely believed that the large surge in the November long gun category was for finished MSRs. These are the items that have been blamed by the media and many political candidates for most tragedies. They are the dreaded "ARs" that are "bad." Some political candidates have done everything they can to make MSRs harder to get, and have tried to outlaw them. (Some states have nearly succeeded) Hence, many Americans are buying them in droves… after all what is more American than buying something only because someone tells you not to or that you can no longer have it! (Ok, sorry... that last sentence was some of my sarcasm coming out.)
If MSRs were responsible for the large increase in long gun NICS checks, we can expect a drop-off in NICS in the long gun category. However, that is not a perfect sample for us. The overall NICS checks including handgun and the "other" category can clarify this. If a drop in long guns is accompanied by a handgun near the trend line numbers, it suggests that buying has indeed continued to be strong.
The normal trend line in handgun sales would bring us to a number in the range of 875,000 to 1 million sales for December 2016. That would be an incredibly strong December for handguns! The only other anomaly to deal with was December 2015's massive jump in purchases. (December 2015 had an outlier, banner month with a roughly 44% increase month over month, or a massive 38% increase over December 2014.) Many people will look at only December numbers and assume that demand is going down if the 2015 numbers are not beat. (Technically, they would be accurate in saying the numbers were lower. If they are, however, that is not what the trend line actually says we should expect. Of course, anything above December 2015's impressive numbers would be startling news as well.)
If NICS checks fall too far, we will know if the election removed the impetus for buying all firearms or merely certain types. This is why December numbers are critical to understanding firearm stocks like Ruger and Smith.
Smith & Wesson, soon to be AOBC or American Outdoor Brands Corporation, has telegraphed what it thinks with the expected January launch of a new M&P handgun, as mentioned here. Mr. Debney even pointed it out multiple times.
"Handguns, which made up 83% our firearms unit shipped in Q2" (emphasis added) Or maybe here… "We've demonstrated our ability to create a new product for our firearms brand such as M&P which today generates the majority of our revenue." (emphasis added)
The effect on Smith & Wesson
First, don't believe anyone over the data. According to one Motley Fool writer
"Coupled with the introduction of its own modern sporting rifle, Smith & Wesson has since expanded its business into multiple segments of the long-gun market and perfectly positioned itself to capture the change in consumer preference for these firearms. It saw shipments of long guns more than double last quarter, far outstripping the gains it saw in higher handgun shipments, which rose less than 40%."
- Long guns are a tiny fraction of Smith's market share.
- My NICS research shows handguns are the hottest part of the market. MSRs are becoming more popular than hunting rifles. However, they are being dominated by handgun purchases which suggests personal defense, or fear/safety, is a bigger driver of growth.
- The "other" category is small, but growing rapidly according to NICS. (This is one area that Ruger entered in Late November when it announced it was selling lowers to the market so individuals could customize their own MSR.)
I have mentioned numerous times, that Smith appears to be modeling itself after Vista Outdoor as it moves away from a pure play on firearms as Ruger is. While I do not see it distancing itself from the shooting crowd, I do see it adding in businesses that spread its products into the larger outdoor market while using that new outdoor arena to sell more firearms and accessories. This could be very beneficial to it, while possibly reducing the chances for having as many shorts. However, with 83% of its sales coming from the handgun market, it is likely that any change in the NICS handgun sales data will give us plenty of forward guidance for Smith.
The numbers game
Here are my current numbers on each publicly traded firearm manufacturer. Just in case, it's important to note that Vista Outdoor gets roughly 10% of its sales from firearms directly. It gets roughly 44% of its income from ammunition sales which "feed" the firearms market.
Sometimes, price per share can get in the way of a true comparison, however, so I have also included my adjustments in numbers for each company if their share price was more or less equivalent. (In the yellow and red shaded areas, I multiplied each number by the equivalent number to get share prices similar. I believe this to be a balanced way to estimate.
While the PE ratio suggests Smith is a better long-term bet, debt or revenue per share would suggest other companies. If you are looking for stability, I still believe Ruger is the way to go. (However, I do own all three in my portfolio and in others I manage, though in differing amounts.)
While Smith has taken on some debt and expanded at breakneck speed, it had $20.8 million in positive cash flow during Q2 while Ruger's was roughly $19.4 million, if my calculations are correct. This means without all the extra divisions, Ruger is a pure play on the firearm market and doing nearly as well. Ruger also gives out a dividend that is currently 3% and based on 40% of profits per quarter.
Vista, our outlier, has taken a large load of debt from the spinoff from ATK/Orbital. The fact that VSTO has more revenue per share than the actual share price is amazing, something the market would usually pay a high premium for. If it were not for its debt load, it would be easier to recommend.
What to do
December NICS checks will show us a lot, so you might want to wait out the bumpy ride. If you are invested, I would stay put until we know more. However, any large spike in activity is likely to leave many without a good share price. If you have recently bought or purchased more, I would say you are likely well-timed for gains.
As always, it is truly your money and your decision. However, I thought you might want to see the numbers.
Disclosure: I am/we are long SWHC, RGR, VSTO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.