Shot Show 2019: Both Barrels Empty?

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Includes: AOBC, RGR, VSTO
by: Maks F. S.
Summary

Investors of publicly traded firearms companies have been largely rewarded with coal while gun rights enthusiasts have slept in comfort.

A look at the financial results of Vista Outdoor, American Outdoor Brands and Ruger since the 2016 elections.

A discussion of why there is a disconnect between between gun rights and the 2nd Amendment.

A look at the challenges facing the industry and investors in the near future.

In just about a month from now, I will be boarding a plane to go to the NSSF Shot Show 2019 in Las Vegas, NV. For those unfamiliar, Shot Show is the largest industry trade show, bringing together the major players in the firearms industry, connecting buyers and sellers throughout the supply and distribution chains.

Over the previous two years, my message to gun investors was simple, "Even though this will be a great time for gun rights, this will be a very tough time to be a gun investor."

The premise and reasoning behind this is simple, historically, more guns are sold under liberal Democratic leadership than Pro 2A Republicans. In fact, there has never been a time more profitable for the firearms industry than President Obama's 8 years in office.

Why?

Because firearms purchases are durable goods, generally purchased under the premise of fear ... the fear of not being able to purchase them in the future.

If you have followed my previous monthly NICS article series, you would have seen this relationship play out in the massive spikes in background checks in the months following any highly publicized shooting, generally an unfortunate school massacre.

The cycle is simple and predictable.

An unfortunate act of violence occurs. Generally speaking it is done by an AR-15 style rifle, which is the most commonly sold sporting rifle. Liberal groups focus on the style of rifle, wrongly focusing on the tool of the crime, rather than the underlying cause (mental health). These groups, through the use of the national and social media focus on putting pressure on legislators to "end senseless violence" by enacting tougher gun control. In turn, legal, law abiding gun owners run out to their local gun stores to purchase even more handguns, rifles and ammunition "just in case they are not available in the future."

Fortunately, this chain of events was largely broken when President Trump was elected. Law abiding gun owners became fairly confident that despite best efforts, President Trump would not sign any new draconian legislation and anything enacted would be largely "feel good," such as what we now see with the bump stock ban.

So is this why firearms investors were decimated over the past few years?

Chart VSTO data by YCharts

As we discussed in previous articles, the main problem for the industry and the publicly traded companies is that not only did they get the election results wrong, but that they also invested meaningful capital in growing inventories on the assumption that Hillary Clinton would become president. Had this assumption worked out, it would almost certainly mean millions more firearms sold at exceptionally high prices on the assumption that gun rights would be further restricted.

Where are We Now?

Have all of the dominoes fallen? Or is there more downside?

In the near future we will do an up to date article on the background checks data but needless to say, the numbers are down.

The main problem however is not the volume of transactions but the prices at which they are sold.

American Outdoor Brands (AOBC) and Vista Outdoors (VSTO) had significant inventory built up going into the elections. What was supposed to be a problem for just a few quarters has continued to drag on. Even if all of the inventories are right sized, firearms and ammunition have not been this cheap in over 15 years!

This Black Friday, gun owners were able to purchase fairly good quality AR-15 rifles for as little as $350!

Today, you can get a very nice AR-15 for about $470 from companies such as Palmetto State Armory, the very same rifles which would sell for over $2,000 in the aftermath of the Sandy Hook shooting.

Source: Palmetto State Armory

For anyone handy who can put some basic parts together, can get a complete rifle, less the receiver for under $300.

Source: Palmetto State Armory

Combined with a $40 lower receiver you have a complete AR-15 for under $350.

When it comes to ammunition the prices are just as low.

A box of high quality 9mm ammunition is around $7.50 per box after Vista Outdoor's mail in rebate and 223/5.56 ammunition can be purchased for around $4.35 per box.

Three years ago, those prices would be twice as high.

The Financials

The three major players have indeed suffered since the elections.

Chart AOBC Revenue (NYSE:TTM) data by YCharts

On a percentage basis Vista's revenues have dropped off the least. This would be consistent with the notion that it is better to sell the blades over the razor. Vista's firearms revenues are largely ammunition. Even though gun owners may not need to buy another gun, largely, they need ammunition.

The thought here however is ... IF there is a record amount of new shooters entering the sport ... why are the revenues still declining? In either case, what is still concerning is that I believe a good drop in ammunition prices has not yet been reflected in the revenues.

Furthermore, the revenues do not reflect the key driver of ammo purchases the last two holidays ... REBATES! Lots and lots of mail in rebates which would show up on the expense side of the income statement rather than the revenues.

Of course, the 25%+ revenue drop for both American Outdoor Brands and Ruger (RGR) is not surprising.

Chart AOBC Revenue (TTM) data by YCharts

This then translates into a large drop in net income and of course every valuation model based on a price/earnings multiple.

Chart AOBC Net Income (TTM) data by YCharts

And yes, Vista Outdoor (VSTO) is continuing to lose money.

Chart AOBC Net Income (TTM) data by YCharts

Lower sales at lower margins leads to lower profits. Simple.

So what about those high inventories?

Chart AOBC Inventories (Quarterly) data by YCharts

Well ... at least it seems that one management team has gotten the memo.

Chart AOBC Inventories (Quarterly) data by YCharts

The only one who has made meaningful cuts to their inventories is Ruger. This is not surprising considering that after my interactions with the management team, I came away with the notion that they were one of the few companies that seemed to be fiscally disciplined.

Vista's inventories have also declined more than 23% over the last two years consistent with their promises, however a part of this would also reflect the divested brands.

... and then there was the debt.

Chart AOBC Total Long Term Liabilities (Quarterly) data by YCharts

This has been another issue of mine over the previous few years.

As I discussed after Shot Show 2018, there were generally no ongoing concerns for Ruger as the company's focus on profit sharing in the form of the dividend and a lean balance sheet made it fairly simple and comforting for investors to come up with what they believe is a fair stock price. In the case of Vista and American Outdoor Brands, there were questions of how long the company can survive with the debt.

Fortunately Vista has indeed started to deleverage and pay down debt by selling off non-key brands. Most recently they were able to refinance their debt which should provide more peace of mind. Unfortunately, American Outdoor Brands breaks the mold and has increased their debt along with their inventories.

To be fair, debt by itself is not an issue if it can be serviced and used for the right reasons and invested in projects which would increase the overall return on investment. The issue with debt however is whether it will help the company take advantage of opportunities or be spent on projects and expenditures which will not work out. A good way of thinking about this would be like borrowing money to go gambling. If you win, it is great. If you lose, you still owe that money and have nothing to show for it.

As stated earlier, the mere notion of "good times for the 2A" has decimated AOBC and VSTO investors, particularly since the Presidential elections.

Chart AOBC data by YCharts

What should have current investors concerned is that it occurred in what is believed to be a very strong and vibrant economy.

The question is ... "What will a recession or an economic downturn do over the next few years?"

Has industry collectively shot both barrels and missed? Are we now waiting to see the potential damage? Or perhaps there is more they can do?

Going forward we will attempt to answer these questions and others in a series of articles as we did last year.

For more reading on the firearms industry, please take a look at my previous articles,

As always, thank you for reading and your discussion.

Author's Note: For my regular readers, I am glad to be back and contributing after a very difficult 6 months or so. Between a number of family matters and a move, my time was severely cut. Now that I am setup in my new location, looking forward to continuing where we left.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.