Sturm, Ruger & Company (
RGR) is a firearms manufacturer that makes
and markets four different kinds of firearms: rifles, shotguns,
pistols, and revolvers. The company also produces investment castings
for third-party sale when there is excess capacity not needed for its
own products. Products are sold mainly to independent wholesale
distributors, who then resell to retailers primarily in hunting and
sporting markets. Ruger is basically a U.S.-only company, with less
than 4% of sales coming via export.
Ruger's appearance on the Magic Formula screen is a classic case
of fooling the parameters due to a cyclical situation - this time the
widely reported "gun boom" that started in the forth quarter of 2008
right after the election of President Obama and has continued through
most of 2009. Many were worried that the new administration would
re-enact the assault weapons bans of the mid-1990's. This fear combined
with the prospect of another Great Depression leading to widespread
crime and desperation created a perfect storm for firearms sales. Gun
shows were packed, with lines wrapping out the doors and down the
streets. Ammunition at many suppliers was sold out. Both Ruger and
other public gun maker Smith & Wesson (SWHC) reported unit demand
doubling from normal levels.
Certainly, Ruger has benefited greatly from these developments.
Sales in 2009 are going to come in 60% above 2008. What's more, the
company's recently announced SR-556 assault rifle has been a hot
seller, and it is one of Ruger's most expensive and highest margin
products. Average selling prices have been trending upwards and factory
utilization is full-tilt. These factors show up in gross margins, which
have been right around 30% for the past 4 quarters, vs. a 5-year
average of 20%. Put it all together and the profit story is fantastic -
Ruger has earned over $44 million in operating profits over the past 4
quarters, putting up big returns on capital (52% normal and 83% by MFI
calculations). At the current price, with investors pricing in a
bursting bubble, the trailing earnings yield is a massive 26%. Bingo,
the "magic combination" for a spot on the MFI screens.
However, before we invest, we need to ensure that the earnings
levels and returns on capital are sustainable going forward. Here,
Ruger clearly fails any in-depth examination. There is ample evidence
that the gun boom is coming to an end. Q3 orders plummeted, down 36%
from a year ago (which represents a more normal level). Backlog has
declined almost 50% from where it was at the end of Q1. Signs of the
boom ending are also evident in the moves by some noted private equity
groups.
