1. Morgan Fourdrigniez
1101 New Hampshire Avenue, NW 20037 DC.
TELEPHONE (202) 420-8045
Sturm Ruger & Co (RGR, $36.12, 12/12/2014)
Introduction: I am recommending a long-term investment in Sturm, Ruger & Co (RGR). The
company is a leading firearms manufacturer in the US— 93% of revenues are US-based. The story of
Sturm, Ruger starts in 1949 when William Ruger and Alexander McCormick decide to rent a small
shop in Connecticut and start the production of firearms. Their first product launch — the MK II—
was an instant hit, launching the entire company. Following this launch, the company would pursue
what was nearly half a decade of product innovation focusing on quality, technology and innovative
operating methods. (Prior to Ruger and McCormick’s partnership, Ruger had borrowed money to start
a firearms company on his own. Ruger went bankrupt, and this event has embedded the company with
a culture of reluctance towards leverage.)
From the 1990s to early 2000, under William Ruger, the company ROE ranged from 15% to
30% a year. Following Ruger’s death, his son William B. Ruger, Jr. took over as CEO and directed
the company from 2000 – 2006. Ruger Jr’s poor management during this period resulted in revenues
declining from $200 million to $150 million, almost resulting in negative earnings in 2005.
In 2006 Michael Fifer took over, resolving all the issues Ruger had been facing (poor
manufacturing methods, building inventory, lack of R&D— key to durable goods as new product
launches represent close to 30% of revenues each year— and poor capital allocation methods.) Since
Fifer’s arrival, productivity has increased by 50%, WIP inventory was reduced by 70%. Moreover, a
new capital allocation philosophy was instilled. – No target pay out ratios. Instead, “The company will
use its cash to generate shareholder value, or it will be returned to the shareholders.”(2007 annual
report)
When Obama was elected in 2008, talks on more firearms regulations mounted. The fear for
more regulation pushed demand to unprecedented levels, driving the demand of retailers, which in
turn drove RGR’s sales. Recently, retailers have been too optimistic with this mounting demand (CEO
Fifer had warned retailers of being too optimistic). YOY sales plummeted 43% in Q3 earning. The
stock is down from an all time high of $85.3 at the beginning of the year and now trades at $36.12.
The stock trades at about 2/3rds
of intrinsic value or a margin of safety of about 30%.
Reasons for Undervaluation: There are two primary reasons why RGR is undervalued. (1)
The industry is (at the retailer level) facing an inventory glut. Retailers must therefore solve this issue
for demand to take off again in the industry. Note: Demand for firearms by end-users has not
decreased. The National Instant Criminal Check System—a measure of firearm demand—shows
demand being at the second highest level in 16 years. (1.33 million) (2) Capital allocation from
management and the nature of the business is a deterrent to many investors. Regarding the former,
management distributes dividends and buy’s back shares on a non-consistent basis. Investors seeking
a consistent capital allocation policy are deterred. Regarding the latter, many institutional investors

2. (the socially responsible ones that is) do not wish to hold a firearm company in their portfolio.
Recent Developments: In
early
2013
an
unanticipated
strong
drop
in
sales
occurred
as
fear
of
gun
control
reseeded,
combined
with
over
optimism
at
the
retailer
level.
Inventory has built up
and as of Q3 of 2014, the combined increase of inventory at the independent wholesaler and RGR
increased by 63 000 units.
Valuation: The
main
assumption
here
is
that
RGR’s
recent
drop
in
earnings
is
associated
to
an
inventory
glut
issue.
Facts
point
towards
this
assumption
given
that
NICS
data
hasn’t
flinched.
Nonetheless,
the
recent
impressive
revenue
profitability
levels
are
not
sustainable.
I
assume
NOPAT
to
normalize
towards
it
2010’s
11%
levels,
from
a
17%
high.
Capex
is
assumed
to
be
at
around
7%
of
revenues,
based
on
historical
data.
We
calculate
the
After
tax
FCF
in
Exhibit
1(adding
back
depreciation
and
subtracting
change
in
NWC.)
Price to FCF Multiple:
An analysis of the historical Price to FCF multiple in the industry multiple of shows a multiple
average of 17x. To be conservative, a 16x multiple appears highlighted in exhibit 3. Using this
multiple valuation sets a price per share expectations of $51.96 for 2016.
2014
2015
2016
2017
2018
NOPAT
$60.00
$51.00
$59.00
$63.00
$61.00
Cap
Ex
$40.00
$35.00
$35.81
$38.54
$40.79
After
Tax
FCF
$38.00
$45.00
$63.00
$65.00
$61.00
FCF/share
$1.96
$2.32
$3.25
$3.35
$3.14
12
$23.51
$27.84
$38.97
$40.21
$37.73
Multiples
14
$27.42
$32.47
$45.46
$46.91
$44.02
16
$31.34
$37.11
$51.96
$53.61
$50.31
18
$35.26
$41.75
$58.45
$60.31
$56.60
20
$39.18
$46.39
$64.95
$67.01
$62.89
Exhibit
1
(in
millions)
Exhibit
2
(in
millions)

3. DCF: While the above cash flow multiple analysis appears to be a better valuation tool here because
of the long term uncertainty, a discounted cash flow analysis yields similar results. A DCF using the
FCF showed above assuming no growth after 2018 and a 15% required rate of return, we calculate a
value of $40.88 per share (exhibit 3 below). Simply assuming a conservative growth of 3% for
terminal value yields an estimate of $48.69 per share. So according to our DCF model, shares should
be worth $40.88 at the lower conservative estimate, and $48.69 with a 3% growth in perpetuity.
Risk of Permanent Capital Loss: The most prominent risk is likely that of increased
regulation. Historically, gun regulation attempts have been implemented at the federal level. However,
regulations are coming more and more from the state level— a more effective way of implementing
regulations. The regulations tend to target the assault riffles segment— such as President Bill
Clinton’s Federal Assault Weapons Ban (AWB) law. Although this increased regulation is a risk of
permanent capital loss, the paradoxical effect of such risk is increased sales in the shorter term, which
provides a cushion against the risk of permanent capital loss.
The Balance Sheet: RGR’s balance sheet is in pristine shape. The company has about $45
million in cash and no debt. The lack of debt and surplus of cash speaks to management’s capital
allocation ability and strategic planning and leveraged-averse historical influences (unlike Smith &
Wessons, which is highly leveraged). The position allows the company to easily fund any acquisitions
deemed desirable.
Summary: RGR has been a leader in the industry for a nearly half a century. The industry’s high
regulation provides strong barriers to entry. Moreover the trends in regulations tend to target the
assault riffles segment, which Ruger has limited exposure in. Ruger is extremely well managed, and
Ruger’s the fundamentals of the company are impressive.
Recommendation: BUY
FCFF
38
45
63
65
61
Required
Return 15.00% 15.00% 15.00% 15.00% 15.00%
CFs 33 34 41 37 233
TV 407
NPV 785 40.88 $/share
Exhibit
3
(in
millions)