Recently, the two major gun manufacturers Sturm, Ruger & Company (NYSE:RGR) and Smith & Wesson Holding Corporation (NASDAQ:SWHC), as well as chemical manufacturer Olin Corporation (NYSE:OLN) who makes Winchester ammunition, published their latest earnings reports. Five common themes affected these three companies.
Gun control policies out of Washington D.C and fears of crime rate increases sent consumers into a panicked buying frenzy. The gun consumer asks, “If you can’t feel safe in a school, where can you feel safe?” and “If the government is going to take our right to bear arms, I will buy as many as I can and hide them so that I can feel safe against criminals and government oppressors.”
All of this translated into sales increases of 52%, 39%, and 27%, respectively, for Sturm, Ruger & Company (NYSE:RGR), Smith & Wesson Holding Corporation (NASDAQ:SWHC) and Olin Corporation (NYSE:OLN)’s Winchester unit in the most recent quarter. Over the past year, Ruger, Smith & Wesson, and Olin beat the S&P 500 total return index with a 46%, 37%, and 15% return respectively as of this writing (see chart below).
Both Ruger and Smith & Wesson reported low inventory across the supply chain. Fearful gun consumers go into the stores and clear the guns off the shelves. This puts retailers in a bind and they order off the distributors who then pass the buck onto the gun manufacturers who strain capacity to get the guns into the hands of customers.
Sturm, Ruger & Company (NYSE:RGR) estimates its “sales through rate” or sales from distributors to retailers grew 63% in 2012, indicating heavy demand according to its latest earnings call. Ruger uses sales through rate to manage its business since it more accurately depicts the dynamics of the industry.
Surge in gun demand led to uncomfortably low inventories for retailers. This in turn led to retailers ordering more than they need from the distributors and the distributors in turn ordering more than they need from the gun manufacturers. All of this added up to annoyingly high levels of backlog that may never translate into sales. Sturm, Ruger & Company (NYSE:RGR)’s CEO, Michael Fifer, doesn’t even use it as a metric in managing the business and would hardly discuss it on a forward basis during the last earnings call (log in required).
Backlogs expanded exponentially in 2012. Ruger’s 2012 backlog stood at 1.5 million units “more than double” the amount in 2011. Smith & Wesson Holding Corporation (NASDAQ:SWHC)’s backlog expressed in dollar amounts tripled to $668 million in its most recent quarter compared to $199 million the same time last year according to its latest earnings call (log in required). The backlog in Olin Corporation (NYSE:OLN)’s Winchester unit grew nearly tenfold during 2012 to $264 million as of Dec. 31 according to its latest earnings call (log in required).
In the Motley Fool video, “Sturm, Ruger & Co. Earnings: Is the Arms Race Over”, Fool analyst Blake Bos believes that the current sales trajectory in the industry reside at “unsustainable” levels. I agree with him. Once the fears over outright government oppression and crime rates subside a little, the demand will ease up along with the stock prices in the short term. Further evidence reside in the 28% increase of law enforcement sales in Olin’s Winchester unit in its most recent quarter.
Sturm, Ruger still possesses no debt on its balance sheet. Smith & Wesson is catching up with Ruger on that front with a 13% year over year reduction in long term debt to equity going from 44% in the 3rd quarter of fiscal year 2011 to 28% in its most recent quarter. Smith & Wesson also expressed an interest in paying down more debt in the future.
In summary, when fears stemming from politics and crime rates subside a little, demand will fall and some of the back orders will mysteriously disappear without being converted to orders. The fundamental bubble driving the gun and ammunition rally will reverse in the short term. Meanwhile, the clean balance sheet of Sturm, Ruger and the deleveraging of Smith & Wesson’s balance sheet will give these companies the flexibility to operate through lean times, adding to the long term potential of both.
The article Gun Stock Earnings 5 Takeaways originally appeared on Fool.com and is written by William Bias.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.