( HDI) backfiring and
in the can, the past year hasn't been the greatest for famous American consumer brands associated with the great outdoors and sunny summer months.
But two U.S. icons have started the season off with a bang. Both are small-caps:
Smith & Wesson
( SWB), maker of the nation's most popular line of revolvers, and
Sturm, Ruger & Co.
, maker of the nation's most popular line of pistols.
There are a number of structural, legal and specific reasons why shares of the country's only two public firearms manufacturers are blazin'.
Let's start with Smith & Wesson, probably most famous as the original manufacturer of the powerful .357 Magnum pistol. This is a company that has had more owners over the past 150 years than your basic Saturday night special, but its latest group of executives appears to finally have it on track. Founded in 1852 by Horace Smith and Daniel Wesson, it passed through any number of hands, including earlier incarnations of the auto-parts makers
( TKS), before merging with a small public outfit called Saf-T-Hammer in 2001.
Shares kicked around the $1 level for a while, then spent three years at around $2 to $2.50 before shooting up to the $4.50 zone in the past three months. The stock went up 13% right after the terror attacks in London. Smith & Wesson's new leaders have expanded its focus from its niche in consumer handguns under the Smith & Wesson and Walther brands -- 80%-plus of current sales -- to take aim at more commercial opportunities in the $2 billion market for U.S. firearms. It has also indicated it will launch a long-gun division -- the industry term for rifles and shotguns. These would be the first with the Smith & Wesson label.
Market Dominated by Europeans
Until now, three foreign companies have, strangely enough, dominated sales of high-end firearms to U.S. law enforcement officers and the military:
of Italy and
of Switzerland. On July 14, Smith & Wesson continued its move to break their stranglehold on the domestic market by announcing it had hired two former Glock sales leaders into its top law enforcement sales posts.
Two weeks ago, the company announced it had hired a former top official of a major Beretta division to head up its effort to enter the long-gun market. S&W is already the largest U.S. maker of handcuffs, so it already has salespeople talking to law enforcement agencies.
It should do well in its new fields. Recent industry surveys have shown that buyers consider Smith & Wesson their No. 1 choice, even in product areas in which it does not now participate, such as shotguns and ammunition. Eric Wold, an analyst at the San Francisco-based brokerage Merriman Curhan Ford, said the company may also diversify into the "less-than-lethal" niche -- the province of pepper spray, stun guns and beanbag guns.
Wold is the only analyst with published earnings estimates. Without including anything but forecasts for the consumer handgun division, he sees the potential for Smith & Wesson to earn 16 cents per share in fiscal 2005 and 21 cents in 2006. If you put a 25-times multiple on 2006 earnings, you get $5.25, or more than 16% above its current perch at $4.51. If you think that its efforts to push more powerfully into the law enforcement and long-gun markets will be successful, you could estimate the company might earn 30 cents a share or more in 2007.
The sooner the company makes the break toward a wider sales opportunity, the better. According to numbers assembled by Wold from federal sources, the rate of growth of the $460-million-a-year handgun market has slowed down to a 3.6% clip. That's not enough for Smith & Wesson to maintain its current share price. To gain more new users, the company has used some of its cash hoard to innovate. It has done well with a .50-caliber Magnum, dubbed the Model 500, which reportedly has three times the muzzle energy of a .44-caliber Magnum round. (The Model 500, whose barrel is more than eight inches long, is mostly marketed to hunters.)
Wold reports that the gun generated 8% of total revenue in its first full year of sales and doubled sales in the most recent 12-month period, to 21,700 units. He said S&W introduced 14 new products at the year's big trade show in Las Vegas -- much more than its competitors.
On the law enforcement side, Smith & Wesson apparently does well as a backup firearm, though it has struggled so far in its quest to become officers' primary weapon. There's a big marketplace out there. Federal statistics indicate there are nearly 710,000 sworn officers at nearly 18,000 agencies around the country. According to Wold, 65% of recent New York Police Academy recruits chose S&W side arms after graduation. However, contracts with agencies come up for renewal only every five to six years, so it is not an easy market to crack.
The Military Market
As for the military, the company recently won its first federal contract in 15 years -- a $1.2 million deal to supply 4,750 semiautomatic pistols to the U.S. Army Security Assistance Command, which shipped them to the Afghanistan National Army. Wold notes that with a better lobbying effort in Washington, the company would have been eligible for major deals recently won by foreign competitors, including a $19 million contract to supply 50,000 side arms to the Coalition Provisional Authority in Iraq (that contract was won by Glock); a $24-million contract to supply 65,000 pistols to the U.S. Department of Homeland Security (won by Sigarms); a $4.2 million contract to supply pistols to the U.S. Coast Guard (won by Sigarms); and a contract to supply 18,744 pistols to the U.S. Air Force (won by Beretta).
S&W's effort picked up some firepower last month when the Department of Homeland Security's budget was approved with an amendment that requires federal agencies to buy products made from at least 50% U.S. goods and labor. And its licensing and marketing efforts are beginning to look brighter. It has shed a previously unfocused strategy to bear down on the sort of consumers who have made Nascar the most popular sport in America; it has sponsored a SKI Motorsports-owned Chevrolet on the Busch Series tour, No. 30 on your scorecard, and sells branded merchandise at races.
Sturm, Ruger: Simpler Story
Trading at a market cap of nearly $240 million, Sturm, Ruger -- run by the 65-year-old son of co-founder William Ruger -- earned $4.1 million over the past 12 months on revenue of $149 million. Shares have fallen 21% in the past year. But amid recent signs of stronger sales of its pistols, rifles, shotguns and precision titanium castings, they're up 35% in the past three months from their May low. The company's balance sheet is a thing of beauty, with $35 million in cash and no debt -- and, remarkably, it pays a 40-cent dividend that provides a 4.6% yield.
Like Smith & Wesson, Sturm, Ruger has positive brand recognition and loyalty among hunters and military buffs. The company is seeking to capitalize on it this year by releasing a dozen new products.
And both may come to have a takeover premium. The firearms industry has more than 160 small manufacturers, virtually all private. Thus, it's ripe for some consolidation eventually.
Richard Cuniff, a highly regarded value investor (and a Warren Buffett brother-in-arms), is a board member who bought 20,000 Sturm, Ruger shares at $8.60, or right around the current price, a year ago after shares were killed in the wake of a dividend cut. He bought another 20,000 shares two months ago in the mid-$6s.
And if you believe, as C.L. King analyst Jim Barrett does, that the company will earn 50 cents a share in 2006, up 25% from full-year 2005 estimates of 40 cents, then the forward price-earnings multiple of 17 looks very reasonable. If you put a 20-times multiple on potential 2007 earnings of 60 cents, you can see the potential for $12 shares in the next 18 months, which would give you about a 50% total return in combination with the big dividend.
Lawsuits Fading Away
One reason that prospects are brightening for this pair is that their legal exposure is fading. Barrett noted that lawsuits against gun makers by local governments have repeatedly been dismissed by courts, and laws in 34 states prohibit any action at all. On the federal level, a bill called the Protection of Lawful Commerce in Arms Act -- which would bar future civil action by municipalities -- has been passed by the House but is blocked in the Senate.
Either way, it looks like investors in these two gun makers could shoot the lights out over the next couple of years as long as they exercise a little patience with volatility along the way.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Smith & Wesson and Sturm, Ruger & Co. to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Jon Markman owned shares of Coca-Cola.
Jon Markman, writer of TheStreet.com Value Investor, is the senior investment strategist and portfolio manager at Greenbook Investment Management, a division of Greenbook Financial Services. Separately, he is publisher of StockTactics Advisor, an independent weekly investment research service. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback;
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