Sunday, December 23, 2012

Sturm Ruger: Looks So Good, That It Can't (or couldn't) Be...

This is a post that I wrote on May 3rd after I had a few bourbon and cokes. Apparently, I forgot I wrote it (obviously, I just had a few...) and stumbled upon it when looking at some old drafts... Ruger was trading for $54.7ish at the time and later bottomed out at ~$35 bucks. Since then, it has rebounded quite nicely and has gone back down, and about every other direction- however, at no recent point have I wanted to own a part of the company... This article is out of date in the short term but (I think) is relative to the long... This is especially true in light of recent gun related tragedies. I have made a few minor changes, but, the premise is still there... I don't wish to get into a debate about gun rights or anything like that. This is strictly investment thesis oriented piece and not an emotional or political issue.

Sturm Ruger is one of those companies that I have followed for a long time. I like their products, sold them in a pawn shop I worked at, and can personally attest to their quality/value. However, as of now, I wouldn't trust any of my money to be invested in their stock. In fact, the only time that RGR looked really cheap to me was when it was in the single digits in 2008/2009... But that was when I was investing in IBAL, CTHR, and BH (formerly SNS) and others- RGR just wasn't cheap enough compared to everything else at the time for me to take the plunge.

There are a lot of things to like about RGR... for one, they have no debt and don't seem to like taking it on. Recently, the company's cash levels have swelled (an understatement). In the last 5 years they did some major changes to their production line and became a drastically more efficient company (there use to be a really good presentation on their website and it may still be there- if so, check it out). The company likes dividends and repurchases it's shares regularly. If capital allocation isn't enough, the company recently went from making guns that were relatively antiquated such as "cowboy style" six shooters to making some that I would be willing to consider as an alternative to my favorite handgun, so you have a sort of product revitalization play going on as well. My dad the previously mentioned SR9 that it is a joy to shoot. Hell, I even like the LCP that they introduced a few years back- at the time, it took weeks to get as it was on back order for ever. Despite that, the company didn't use it's pricing power due to a lack of real competition in the product's niche (well, other than Kel-Tec). I was kind of surprised by the move, actually, as every dollar they increased the price would have gone straight to the bottom line, without doing much to curtail demand for the product. That said, a pretty neat piece despite it's need to be fixed in a costly re-call (which the company seems to do an embarrassing amount of).

Getting back to the stock, Ruger's most recent press release couldn't possibly have contained more good news. The company even raised it's quarterly dividend by 67%. Ruger received orders for more units of product in the first quarter of 2012 than it did in the whole of 2011... as such, the company suspended new orders on March 21st and expects to begin taking them again at the end of May- which, one would presume, would create a scarcity for their product. All I can say in regard to that is "WOW."

The company said the following:

"We believe that Ruger is the first firearms manufacturer to build and ship more than one million firearms in one year."

No pun intended, operationally, the company has hit a total bulls eye.

Does this make for a good stock to own? Personally, I would say "not totally." It isn't that I would want to short the company, but rather that I don't want to be long (which is a stance that I will admit to having since it was trading for less than 1/2 present price levels).

First and foremost, I absolutely hate the industry from an investment perspective. To me it is like a hyper cyclical stock- only it's based on the gun toting public engaging in a political war with people that want to see the company put out of business, rather than economic health to stay a float.

From a societal perspective, firearms are something that will without a doubt, become more regulated in the future. I view this as a truth that will come about partly as a result of our population moving to cities where there are fewer chances of people shooting Ruger's products. It has been my experience that most people are generally scared of guns due to news stories that are made to scare people rather than enlighten them. Even when I bought my first couple, I felt like I was doing something wrong... It is all about exposure to the item (and this is coming from a guy that worked in a pawn shop for a year before he bought his first gun). Once someone actually fires a gun, they generally get an appreciation for how safe they can be when properly used/stored and how it is nearly impossible for one to "just go off." Without people living in the country (as in, the middle of nowhere, USA, where AJII's mini mill is located) where it is really easy to shoot, there will likely be less demand for the product (which, to some extend, may also apply to ammunition manufactures).

As such, with a population that is quite polarized, it could be likely that this industry that will eventually die a pre-mature death due to legislation and a changing culture. Under the previously instated assault weapons ban, various types of weapons and clips were outlawed from being manufactured, but not to sell or own. Legislation of this nature could really hurt the demand for Ruger's products. Even one of the company's leaders supported such action.

While I am generally a big fan of old PP&E on a company's books, I wouldn't be surprised if the impressive amount of property that the company owns would be subject to some sort of environmental or health liability due to the nature of it's age and the type of product that Ruger makes (granted, I don't have any hard proof on this, but it's a gut feeling). This alone wouldn't scare me; I would imagine that it's a similar case at other industrial firms. However, when combined with a host of other risks, should be noted.

Another item that I absolutely hate about the firearm industry is that is is constantly ripe for product liability lawsuits. People absolutely hate industries that make things that contribute to the killing people. If it isn't tobacco or asbestos, then it's the fast food industry. At some point, the civilians weapon industry is going to be on the chopping block again. Ruger has historically had a lot of legal action taken against them and recognizes all that's noted in their risk factors. Public opinion is a messy thing to have to contend with and frankly, I view this as a black swan that is pretty easy to see flying in at some point- I just don't know when it will be.

When considering the potential for repeat business, guns generally don't degrade over time. It isn't as if they continually improve in the same way as say, an Ipod or Intel processor. An Ipod (like Moore's law) doubles its awesomeness every few years and historically, on a parabolic basis as has been the case with computer processors. Firearms don't. While Glock really stepped things up ~3 decades ago, many of the best weapons out there are decades old. The AK-47 is unrivaled for what it does and the design is over 60 years old- they shoot well, are super reliable, ammo is cheap, and they are a joy to shoot. The Colt 1911A is over a century old and is basically unchanged. It was the side arm of the US Armed forces until Beretta beat them out (which was really contested) a few decades ago.

Ruger's products can be used forever if properly taken care of (and generally, they are). Coke sells a one time use product that you can stock a pantry with and not feel guilty about. Stocking a pantry with Ruger's products gets expensive really fast, is impractical (anyone that thinks they can take down the government with a few guns and their buddies is totally missing a grounded reality), and will generally ensure that you don't get many dates or that your wife will get angry with you... Given that Coca Cola has higher margins and a likelihood of repeat business in the future, it stands to reason that Coke should sell at a significantly higher p/e multiple. As of now, KO demands ~10% more of a P/E than RGR (keep in mind, this was accurate as of May 3rd- the spread is now much more apparent). Apple sells for a discount to RGR and every product they sell practically comes with a guarantee that they will sell an upgraded version of said product or a complementary item in the not so distant future. If you sell a durable product, you need a steady or increasing amount of demand to do much for capital appreciation. 

From where I sit, Ruger is a bet on a company that you are betting will cash flow an adequate amount before it dies off or changes direction. The liability issues could be a company wrecking black swan that occurs before a large payout to shareholders occurs. I have no doubt that recent events in the news will help the company's sales, but from where I sit, there is simply too much low hanging fruit out there for me to make this bet at what seems to be an excessive price, where even with the recent destruction of nearly 1/3 it's market cap, trades at a price that seems to want there to be future earnings growth.

Disclosure/Disclaimer: I have no position in regard for or against any of the entities mentioned, except for 1 share of IBAL that is owned by an investment partnership I am a member of. I also own some shares of ALJJ. I reserve the right to change my positions at any time. This post is my opinion. Always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

Sunday, December 9, 2012

Nazis, Human Behavior, and Julian Assange.

I got this article in an email from my cousin, in which, the rules of war were followed due to a sense of Geneva Convention style honor by a German pilot in WW2- a rare thing, based on various references for the battlefields and camps...

Being the contrarian that I am, I immediatly thought of one of the most fucked up modern videos (I challenge you to find better words to describe it with) that I have ever seen:

Thanks go out to Julian Assange for that one. As in interesting tidbit, almost 80% of Americans thought that we were justified to invade Iraq- what do you think that number is at present? My guess is that people have a bad memory of what they thought at the time, or are overly willing to change their opinion and not admit it. I for one, will say that I was for the war, which was an unfortunate trait from my neo-con days. Regardless, I would love to see some data of war support before and after watching the video above.

Moving on...

Certainly, bad things happen in war- often, otherwise decent people don't examine things enough and find themselves (what I hope is) unknowingly committing some pretty egregious acts, as illustrated in the Milgram experiment... Speaking of which, even now, after the experiment was talked about in virtually every high school across the nation, people are willing to kill others as long as they are not held fault (kind of like a lot of war crimes committed by the victors of a war). See the video below.

All I am getting at, is that when examining current world events, where our nation continues to play a political game in the middle east that is only worthy of gossiping high schoolers, maybe we don't quite know what we are getting into. Looking back, it's a basic theme throughout history...

I think that this works as an illustration of how no matter how "advanced" society gets, we still deal with the same basic human fallacies, be they blindly respecting authority, thinking in a herd mentality, or, simply loving to be ignorant. Hell, we still love the same plot themes that the Greeks did millennia ago- I would have thought that we would have moved on by now!? Despite Steven Pinker arguing that we are more civil than ever (which, despite the tone of this post, I agree with) these are things that still exist, where a true contrarian and value investor can profit from the acknowledgement of.

Hence, some of the many reasons why I am long a couple of defense stocks that are already astonishingly cheap even if we don't decide to kill a few (or a lot) people in some far away place. To me, being long cash rich defense parts manufactures which also seem to have nimble operations, are a great hedge (if not unfortunate one), regardless of what happens with the budget. If the world falls apart, then they make a ton of money. If the world continues as is, then they are still cheap. If the world gets better, then I would guess that the market would appreciate their cash, or, it could be distributed. If the companies own some real estate that's (probably) understated on the books, then all the better...

Disclosure: None, though anybody that reads this probably knows that I and accounts that I manage are long MPAD and SODI. This is in no way advice. Always do your own research in regards to anything that I say, do, write, or so much as even think about.