Is Sturm, Ruger & Company's Increased Buyback a Bad Idea?
Sturm, Ruger's SR1911. Image source: Sturm, Ruger & Company.
Yesterday evening, Sturm, Ruger & Company announced it has expanded its stock repurchase program, more than tripling the amount available under its authorization from $8 million to $25 million. But if the 5% drop in Sturm, Ruger shares so far today is any indication, the market sure isn't impressed.
However, if we step back and look at how the company typically approaches capital allocation and share repurchases, I think investors should be pleased with the move.
Is demand waning?
First, it helps to talk about how we got here. Several quarters ago, nearly everyone in the firearms industry made it clear that sky-high demand for their products -- which unsurprisingly began just before the last presidential election -- simply won't last forever. In fact, that's why analysts believe Ruger's earnings are set to decrease in 2014, as evidenced by its disparate trailing and forward price-to-earnings ratios of 13.8 and 14.7, respectively.
But including today's drop and despite a positive analyst initiation early last month, shares of both Sturm, Ruger and competitor Smith & Wesson have each gradually plunged more than 15% over the past 30 days. So, what has everyone so concerned now?
Some of the market's worries likely stem from the fact that both companies recently decided not to sell new semiautomatic handguns in California thanks to a controversial new microstamping requirement approved by the state's legislature.
And though Smith & Wesson plans to continue selling revolvers and certain compliant handguns there, Ruger has called the law "draconian" and insisted its weapons would "continue to be forced off the roster" until the legislation is repealed.
Sturm, Ruger might be stronger than you think
But I still think any lost sales in California will be more than made up for elsewhere.
As I suggested in December, demand for Ruger's products in Q3 drove sales 45% higher year over year, which outpaced overall firearms industry growth as measured by the National Instant Criminal Background Check System. In short, even if overall demand wanes, Ruger may not suffer, as it appears to be taking market share from competitors.
What's more, Ruger has a history of responsibly allocating capital. Consider its variable dividend, which fluctuates with earnings as Ruger consistently pays roughly 40% of net income out to shareholders. That may not sound ideal on the surface, but it's downright refreshing when you consider the negative implications for companies that maintain unnecessarily high dividends at the expense of the long-term health of their businesses.
In addition, remember that Ruger CEO Michael Fifer made it clear during November's quarterly conference call that while it has the cash to do so, Ruger doesn't take share repurchases lightly. Specifically, Fifer insisted that Ruger closely watches a number of historical price metrics and will only buy back the stock if it's in the best interests of long-term shareholders. He elaborated:
A lot of folks who have never actually run the math themselves have concluded that stock buybacks are good in terms of raising the price per share, but they forget that you've weakened the balance sheet when you do it. ... It's not an optimum time to buy stock back now. Now if the market softens a little in '14 the way it softened a little bit in '10, and the stock market overreacts and drives our stock price down, I would imagine we would leap in with two feet. We've got the cash to do it. And we understand the math very carefully.
As a result, and just as the market seemed to have soured on Sturm, Ruger's prospects, investors shouldn't be the least bit surprised with yesterday's share repurchase decision.
To the contrary, I think it portends great things going forward for both Sturm, Ruger and its shareholders.
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