(Published Feb. 8 by Bob Ciura)
Some of the best dividend stocks to buy have a high dividend yield and a cheap valuation. Sturm, Ruger & Co. Inc. (RGR, Financial) offers both.
Ruger’s share price has dropped by 20% over the past year, which has compressed its valuation and elevated its dividend yield.
Ruger is not a typical dividend stock. While most dividend stocks adhere to a policy of constant dividends, Ruger uses a variable dividend policy.
This means the exact dividend will fluctuate each quarter depending on the company’s financial performance. Ruger’s policy is to distribute 40% of quarterly net income. Uneven dividends keep the company out of the Sure Dividend database of stocks with 25-plus years of steady or rising dividends using The 8 Rules of Dividend Investing.
With that said, there is plenty to like about Ruger.
Ruger’s dividend payments over the past four quarters equate to a 3.4% dividend yield.This makes the stock an interesting pick for value or income investors.
Business overview
Sturm, Ruger & Co. was founded in 1949 by William B. Ruger. The company opened with a single $50,000 investment.
Source: Investor Relations
Today, Ruger is one of the largest firearms manufacturers in the U.S. It is a full-line manufacturer with over 400 variations of more than 30 product lines.
Approximately 99% of the company’s annual sales come from firearms, with the remaining 1% from castings.
Ruger’s firearms are sold through independent wholesale distributors, principally to the commercial sporting market. The vast majority of sales take place in the U.S.; exports accounted for just 4% of sales in 2015.
Ruger manufactures three main types of firearms as well as related accessories:
- Rifles (38% of sales)
- Revolvers (35% of sales)
- Pistols (21% of sales)
- Accessories (6% of sales)
The past year has been a difficult one for the share price, but the company itself has performed very well.
Ruger’s sales and EPS increased a respective 26% and 49% through the first nine months of 2016.
The operating climate for firearms manufacturers can vary from year to year based on economic and regulatory conditions. In turn, Ruger’s sales and EPS have been volatile over the past several years.
Source: 2015 Annual Report, page 19
That said, Ruger has produced strong growth over the long term.
Growth prospects
Ruger has positive fundamentals and a positive long-term outlook, albeit with some significant near-term challenges.
Analysts are beginning to suspect that 2017 will be a difficult year for the firearms industry. Specifically, analysts believe sales may slow in 2017 as the banner year in 2016 could have pulled demand forward.
Early indications are that this is indeed the case. According to the FBI, firearms background checks declined 24% in January 2017 from the same month the year before.
If that were not discouraging enough, the competitive landscape is intensifying with several firearms manufacturers planning multiple new product announcements in 2017.
The good news is Ruger is keeping up with the competition by releasing its own new products on a regular basis.
In the third quarter, the company unveiled several new products, including the Mark IV pistol, the LCP II pistol and the American Compact pistols.
Ruger will continue investing in new products to keep up with consumer preferences. This is relatively easy for the company since it has an excellent balance sheet.
Ruger ended the last quarter with $101 million in cash and no long-term debt.
As a result, Ruger has more than enough financial resources to invest in future growth initiatives.
Competitive advantages & recession performance
In a highly competitive industry, it is imperative for Ruger to differentiate itself from its peers. It does this by significant investments in product innovation.
Ruger’s research and development expense over the past three years is as follows:
- 2015 R&D expense of $8.5 million
- 2014 R&D expense of $10 million
- 2013 R&D expense of $6.2 million
Getting new products to market quickly is imperative for firearms manufacturers because consumers are always looking for the next big thing.
New product sales represented 36% of firearms sales in the third quarter of 2016, compared with 21% of firearms sales in 2015.
Therefore, Ruger’s main competitive advantages are its strong brand and innovation.
Another benefit for Ruger is its defensive business model. It tends to benefit from economic downturns, which are typically conducive to higher firearms sales. This is presumably why Ruger’s EPS soared during the Great Recession:
- 2007 EPS of 35 cents
- 2008 EPS of 43 cents (23% increase)
- 2009 EPS of $1.42 (230% increase)
- 2010 EPS of $1.46 (2.8% increase)
Valuation & expected total returns
Aside from a potentially challenging environment in 2017, another reason for the selloff could be that investors are expecting the company’s strong recent performance to revert to the mean.
Ruger stock enjoyed a prolonged rally from 2010 to 2015, outperforming the S&P 500 Index by a wide margin in that time.
Source: 2015 Annual Report, page 17
Whatever the reason, Ruger is now an attractively valued stock. Shares trade for a price-earnings ratio of 11. Since 2000, the stock has held an average price-earnings ratio of 13.
The S&P 500 Index has an average price-earnings ratio of 26.
A caveat to the bullish case is that the company’s earnings may decline. If the firearms industry sees a significant downturn in 2017, Ruger may not be as cheap as it looks if its EPS decline.
On the other hand, if Ruger’s sales and earnings stabilize, the stock could see a significant expansion of the price-earnings ratio.
Given the volatility of the company’s financial results over the past five years, it is prudent for investors to make conservative assumptions regarding Ruger’s future returns.
A reasonable breakdown of future returns is as follows:
- 4% to 6% revenue growth
- 1% margin expansion
- 1% share repurchases
- 3% dividend yield
Even when incorporating a fairly modest forecast for revenue and earnings growth, Ruger could still generate 9% to 11% total annualized returns moving forward.
Final thoughts
The firearms industry had a red-hot 2016 due to a number of terrorist incidents and the presidential election. As a result, a cooldown is anticipated.
This has led to a decline in Ruger’s share price, as investors are anticipating a difficult road ahead. The company, however, has proven its ability to navigate difficult operating climates before.
Ruger has a strong brand, an excellent balance sheet and an attractive valuation. In addition to its 3% dividend yield, the stock could look interesting for value-oriented income investors.
Disclosure: I am not long any of the stocks mentioned in this article.
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