Gunmakers Still on Target for Growth

The firearms industry has had two smoking barrels, but things are cooling off a bit now.

Apr 1, 2014 at 9:28PM

After the rapid-fire growth it experienced last year, the firearms industry is ready for a breather. Both Sturm, Ruger (NYSE:RGR) and Smith & Wesson Holding (NASDAQ:SWHC) still look like they're shooting out the lights, but with FBI background checks for gun applications cooling down considerably, investors might want to lower their sights for gunmakers just a bit.

The number of background checks conducted over the first two months of 2014 is running more than 22% below the year-ago figure. The trend began in earnest last June, according to the FBI, which reports that demand was so heavy over the first five months of 2013 that even though 9% fewer checks were done during the past seven months, the agency still conducted 2 million more checks than they did the year before. If this year's rate holds true, it would be the first time in over a decade that fewer checks were performed one year to the next.

The FBI says a background check doesn't necessarily translate one-to-one into a gun purchase, but it's safe to assume that someone going through the time and trouble of a background check is fairly interested in making a purchase.

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It's evident the gunmakers are experiencing an easing of demand as well. Ruger said it received 20% fewer orders last year than the year before, a period it characterized as being one of "unprecedented" demand. Its ending backlog in December, however, is still some 20 million units more than it was in 2012, meaning the slowdown in checks ought to give it time to catch up with orders.

Similarly, Smith & Wesson reported that net sales surged almost 17% in its fiscal third quarter ending Jan. 31, even though NICS background checks plunged 32% during the same period. Like Ruger, it said the quarter was one of "extraordinarily high" demand, and it cautioned investors to expect negative comparisons as it surpasses last year's numbers and anticipates that comps will continue declining through April or May.

The slowdown is also borne out by sporting goods retailers Dick's Sporting Goods (NYSE:DKS) and Cabela's (NYSE:CAB), which both say the category's torrid pace slowed considerably in the back half of 2013. Dick's said significant headwinds in the guns and ammo department is going to have an impact on performance, as the division represents a big part of its business. Cabela's went so far as to say its comps would be down 20% in the first quarter as a result of the cooling-off period.

I wouldn't take my finger off the trigger, though. Gauging a company's performance against a time frame that was an anomaly will ensure that your valuations are out of whack. Business might be slowing, but it's still elevated historically, and the long-term outlook remains strong.

Shares of Sturm, Ruger are down 25% from their high point but trade at nearly twice the gunmaker's sales. Smith & Wesson, which had lost about a quarter of its value at one point, has since bounced back and trades nearly 80% above its 52-week lows. It also trades at a premium to its sales, but if the coming quarter is as weak as expected, I'd be ready to go back on target if the market gives investors lower price points once more.

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Rich Duprey and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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