Made in America: Firearms

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Guns have always played an important role in our society, ever since a few patriots took up their rifles and stood against an empire.  They have also been a big part of the supporting cast in Hollywood, featuring prominently in the Dirty Harry, James Bond, and Lethal Weapon franchises.  Those movies sold a few tickets and launched some big careers.  The founders of this country thought the right to bear arms was important enough to include in the Bill of Rights to the Constitution.  While firearms have an obvious downside, it is comforting to know that law enforcement officers have quality, American-made tools to preserve and protect the peace in towns and cities across the land.

Tightly Regulated, For Good Reason

The industry has had its share of ups and downs over the years and is highly regulated, but there will likely always be a demand for its products.  Sales of firearms in the U.S. are federally regulated by the Bureau of Alcohol, Tobacco, and Firearms (ATF), which licenses dealers and performs background checks on all purchasers.  The Brady Act, passed by Congress in 1993, led to the creation of the National Instant Criminal Background Check System (NICS) and is maintained by the FBI.  Currently, the firearms sector is enjoying a surge in sales, due to both rising interest in the commercial sporting segment and concerns about tighter government regulations in the future.  While there are a number of manufacturers, the investable universe is limited to two big U.S. manufacturers, Sturm Ruger (NYSE: RGR) and Smith & Wesson (NASDAQ: SWHC).

Sturm Ruger is a manufacturer of a diverse product line of firearms, including rifles, pistols, and revolvers.  It sells its products to both individuals and law enforcement agencies through a network of independent, federally licensed distributors.  Over the past four fiscal years, sales grew 124.8%, as prices remained stable and order rates jumped significantly.  In its latest fiscal year, Sturm Ruger reported sales and operating income of $328.8 million and $63.5 million, with increases of 28.8% and 19.3%, respectively, over the prior year period. Both gross and operating margins reached the highest level of the past five years, as operating efficiencies were realized and new products caught on with customers.  While the ATF reported that total background checks in the U.S. rose roughly 18% in 2011, Sturm Ruger outperformed the industry with unit shipment growth of 24%.  Through the first nine months of 2012, the company has continued to perform well, with increases in revenues and operating income of 48.6% and 72.3%, respectively, over the prior year period.

Meanwhile, Smith & Wesson has also benefited from the industry’s growth, reporting a somewhat less spectacular 39.2% growth in revenues over the past four fiscal years.  In addition to manufacturing firearms, the company is one of the largest manufacturers of handcuffs and is the owner of the Smith & Wesson Academy, the oldest, private law enforcement training academy.  In its latest fiscal year, Smith & Wesson reported sales and adjusted operating income of $412.0 million and $44.9 million, with increases of 20.4% and 152.5%, respectively, over the prior year period.  The company’s profit margins improved due to operating efficiencies gained from its recent facility consolidations, as well as from a sales rebound in the rifles segment.  Results in FY2012 are also looking strong for Smith & Wesson, as management recently updated their sales guidance for the year to $530-540 million, roughly 30% growth over the prior year period.

The Opportunity

How should investors participate in this somewhat maligned, often interesting, growth industry?  They should look at the outdoor specialty retailers, who are gaining market share in the firearms business and offer a wide variety of other products.  The best positioned company in the segment is Cabela’s (NYSE: CAB).  Founded by the Cabela family at their kitchen table in 1961, the company has become the world’s largest direct marketer of hunting, fishing, camping, and related merchandise.  Cabela’s revenues grew 19.6% over the past four fiscal years, as it expanded its retail space by 15.8% and created an entertaining shopping experience for customers.

In its most recent fiscal year, the company reported revenues and operating income of $2.8 billion and $231.5 million, increases of 5.6% and 24.1%, respectively, over the prior year period.  Cabela’s operating margins reached their highest level of the past five years, as it improved inventory management and reduced in-store promotions.  In addition, the company has done a great job of creating loyalty through its Visa credit card reward program.  As of December 2011, Cabela’s had 1.4 million active cards outstanding that were used by customers to make 29% of their merchandise purchases for the year, leading to $291.7 million in additional revenue for the company.  In 2012, the company has continued to perform well, with increases in revenues and operating income of 9.0% and 41.0%, respectively, over the prior year period.  Adding this stock to your portfolio will definitely “make your day”.

rghanley owns shares of Cabela's. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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