After nine straight months of higher industry gun sales, Sturm, Ruger (NYSE:RGR) should finally begin to see the effects of the improving market conditions when it reports fourth-quarter earnings on Feb. 20.

There are also a few other factors that will play in Ruger's favor for the period, even though it's quite possible that on the surface, revenue and earnings might not look as strong as industry statistics would indicate.

An AR-15 laying on an American flag.

Image source: Getty Images.

Waiting for demand to return

Ruger doesn't sell its firearms directly to the public. Instead, it sells them to federally licensed firearms dealers, meaning there is a layer of disconnect between firearms production and consumer demand. To see sales rise, Ruger needs its distributors to increase their inventory levels, but through much of 2019, the gunmaker has been methodically reducing its inventory.

Combined inventories in Ruger's warehouses and at its distributors decreased 18,400 units in the second quarter and 8,600 units in the third.

Gun manufacturers across the industry were also hurt by the bankruptcy of United Sporting Companies, a major firearms distributor, which bet big on the outcome of the 2016 election and lost. Stuck with an oversupply of inventory after gun demand declined after the election, the distributor declared bankruptcy after 85 years in business.

Not only did it make other distributors leery about taking on too much product, it also flooded the market with cheap guns as it liquidated its shelves. And with an excess of supply in the market, distributors don't have to hurry up and order more inventory in advance. They know manufacturers will readily ship to market as necessary.

Ruger has tried to remain above the fray and not engage in discounting in a bid to preserve profit margins. That is hurting it short term as it gives up sales and some market share, but it makes for a more financially sound company over the long haul.

Even then, margins have slipped in recent periods as a result of the reduced sales and production, which the company says drove unfavorable deleveraging of its fixed costs such as depreciation, maintenance, indirect labor, and engineering. 

Sturm, Ruger Profit Margins 2017 to 2019*

 

2019*

2018

2017

Gross Margin

24.5%

27.1%

29.5%

Operating Margin

9.7%

13.5%

14.6%

Net Margin

7.9%

10.3%

10.0%

*2019 figures for the nine-month period ending Sept. 28, 2019. Data source: Sturm, Ruger SEC filings. Table by author.

When demand returns -- and it seems that is now happening -- Ruger will be prepared to supply its distributors with firearms on its own terms.

Not all background checks are equal

Nine months of improving market conditions would suggest demand has been back for a while, but there have been a number of one-off events that skewed results and elevated demand. Some tough new gun control laws were passed in several states that pulled demand forward, while in others, changes to laws resulted in technical increases in the data that don't necessarily mean more guns were sold.

The National Shooting Sports Foundation (NSSF) takes the raw background check data the FBI releases each month and parses it for duplicate background checks. For example, some states require existing concealed carry permit holders be regularly checked to confirm they're still eligible to have a permit. Those numbers show up in the FBI's numbers but are culled from the NSSF statistics, which results in a more accurate picture of market demand.

Chart of adjusted monthly background checks

Note: % change on a year-over-year basis. Data source: National Shooting Sports Foundation. Chart by author.

Alabama was one state that had a change to its background check laws last year, resulting in a 134% increase in checks this past December. The adjusted National Instant Criminal Background Check System data showed there were almost 60,000 more checks during the month, a 4% increase from last year, but over 60% of the increase was the result of Alabama's new law. 

The industry is doing better, just not necessarily as good as certain headline numbers suggest.

Setting up for future growth

Since Ruger has been steadily reducing inventory at distributors, there may be enough latent demand to help boost the gunmaker's sales numbers, but management believes it will still be a buyer's market with a promotional atmosphere in effect.

But as we head into a presidential election year, we could see a return of the panic buying that powered the last sales boom. Tough new gun control policies have been a consistent topic of discussion among the various Presidential candidates. Because Sturm, Ruger has protected its bottom line amid shifting consumer sentiment, it should remain a viable gun manufacturer regardless of the outcome.