Gun Manufacturers Stand To Benefit From An Uncertain 2020 Election

Whether one supports more or less gun control, one thing is certain: the politics behind guns moves markets–and bigly. Following the election and reelection of Barack Obama in 2008 and 2012, gun manufacturer stocks rose sharply on the speculation of gun reform [1]. Between 2008 and 2013, gun manufacturer Sturm, Ruger & Company, Inc. (RGR) went from around $6 per share to around $77 per share. Likewise, shares of American Outdoor Brands Corporation (AOBC) went from around $3 per share in 2011 to around $30 per share in 2016.

The rally was partially caused by fears of increased gun regulation under President Obama. During Obama’s two terms in office, Americans purchased more than $29.1 billion in firearms and $16.6 billion in ammunition, according to a report by the Washington Post in 2017 [2]. This was a sharp increase from the sales during the presidency of Bill Clinton and George W. Bush.

As of 2019, the debate regarding gun control persists. In February 2019 Democrats in the House of Representatives introduced and passed H.R. 8: Bipartisan Background Checks Act of 2019. The bill would require unlicensed gun sellers to sell or transfer firearms only through licensed gun dealers. Under current federal law, unlicensed sellers can sell guns at gun shows, online, and person-to-person without conducting background checks on the purchaser. The bill passed with support from 232 Democrats and eight Republicans and is currently waiting upon a vote in the Senate.

Regardless of whether H.R. 8 passes and becomes law, gun regulation will continue to be a point of contention in United States politics. If history is any indicator of the future, the prospects of increased regulation will continue to influence gun bearing American’s purchasing decisions around presidential elections; thus, depressed gun manufacturer stocks present an opportune investment as the 2020 Presidential Election draws closer.

Presented below, are major retail gun manufacturer stocks that have fared poorly over the past few years:

Most of the stocks presented in the table are categorized as small cap (i.e.: stocks with a market capitalization below $2 Billion), with the exception of Olin Corp. In order to gage the performance and valuation of these companies, the Russell 2000 can be used as a benchmark. As of this analysis, the iShares Russell 2000 (IWM), which is a proxy of the Russell 200, has a P/E of 17.32, a Beta of 1.25, and a 52-Week Percent Change of -5.02%. Presented below is an overview of each company:

Olin Corp (OLN) (5-year, monthly prices)

Apart from manufacturing chemical products, Olin Corp (OLN) manufactures and distributes ammunition under their Winchester brand. The company current trades at a P/E of 10.49, far below the Russell 2000 average. Over the past year, shares are down roughly 35%. According to Olin’s 2018 10-K,

“Winchester reported segment income of $38.4 million for 2018 compared to $72.4 million for 2017. Winchester segment income declined from the prior year primarily due to increased commodity and other material costs and decreased demand for commercial ammunition resulting in lower commercial sales volumes and lower product pricing.”

One of the main components of their ammunition is copper. Between 2017 and 2018, copper prices increased from $2 to around $3.30, or roughly a 65% increase. As of May 2019, copper prices have retreated below $2.80, despite forecasts predicting supply shortages. If copper prices continue their downward retreat, Winchester margins will recover and may benefit from the 2020 election.

Sturm Ruger & Company (RGR) (5-year, monthly prices)

Sturm Ruger & Company (RGR) manufactures and sells firearms in the United States. RGR is the largest manufacturer of firearms in the United States–selling shotguns to bolt-action rifles to pistols. The stock is down almost 13% over the past year and has a P/E ratio of around 18– slightly high than the iShares Russell 2000. According to their 2018 10-K, “almost all sales come from firearm sales in the United States. Between 2016 and 2017, estimated sell-through of the company’s products from independent distributors to retailers decreased 17%. This decrease was attributable to decreased overall consumer demand in 2017 due to stronger-than-normal demand during most of 2016, likely bolstered by the political campaigns for the November 2016 elections” and excessive capacity.

Vista Outdoor Inc (VSTO) (5-year, monthly prices)

Vista Outdoor Inc (VSTO) manufactures and markets consumer products for outdoor sport and recreation. The company owns and operates multiple brands including Federal Ammunition and Speer Ammunition. Over the past year shares have fallen over 35% due to reporting a loss in 2018. According to VSTO’s 2018 10-K, strong sales in 2015 and 2016 were largely attributable to certain public and political events:

“During late fiscal 2015 and continuing into fiscal 2016, firearms and ammunition sales experienced an increase as more individuals entered the market and certain public and political events provided focus on the industry. During the later months of fiscal 2017 and continuing into fiscal 2018, we believe the market has softened due to the current political environment.”

Similar to the 2016 election, the same forces that drove sales for VSTO and the aforementioned companies will likely be present again.

American Outdoor Brands Corporation (AOBC) (5-year, monthly prices)

American Outdoor Brands Corporation (AOBC) is similar to Vista Outdoor Inc in that they design, manufacture, and sell firearms through multiple brands such as Smith & Wesson, M&P, Performance Center, and Gemtech. AOBC shares are down around 20% over the past year, and shares trade at a P/E of around 68–far above iShares Russell 2000. According to AOBC’s 2018 10-K, the company had net sales of $606.9 million, down 32% from the prior fiscal year. Furthermore, the decrease in sales across multiple product lines was attributable to excessive inventory that is expected to persist through the first fiscal quarter of 2019.

Clarus Corporation (CLAR) (5 year, monthly prices)

Clarus Corporation (CLAR) manufactures ammunition through their Sierra brand. Clarus shares are up around 88% over the past 52 weeks and have a P/E of around 38. Formerly Black Diamond, Inc, Clarus Corporation acquired Sierra in 2017. While the stock is expensive relative to the iShares Russell 2000 P/E of 17.32, solid sales growth over the past few years coupled with a strong economy has propelled the stock higher and forecasts to be strong. The 2020 election could serve as another catalyst and propel shares even higher.

Outlook

Upon the election of a Democrat in 2008 and 2012, gun manufacturer stocks rallied upon the fear of increased regulation. The election of a Republican in 2016 caused gun regulation fears to subside. If history is to repeat itself, and given the uncertainty of polling, we believe gun manufacturer stocks will outperform the market in the runup to the 2020 presidential election. A Democrat victory will send the stocks even higher, as gun regulation will be a top priority. On the contrary, a Republican win will once again cause fears to subside, as regulation will be highly unlikely to come to fruition.

The Opportunity

Due to historical market trends and a hotly contested 2020 Presidential and Congressional Election on the horizon, we believe depressed gun manufacturer stocks present ample opportunity for investors with an appetite for small cap stocks. While many of the stocks detailed in this analysis remain depressed due to a slowdown in the gun market, we believe the best way for investors to gain exposure to these companies while minimizing their risk is through uncovered (naked) puts. Detailed below is a theoretical strategy and explanation.

Detailed in the chart above is a theoretical stock portfolio of the aforementioned companies. For this example, we use puts with expirations in 2019 (<6-month expirations). The second column is the current stock price of the respective company. Next is a potential strike price. The discount is defined as the spread between the current stock price and the strike price; in other words, the percentage the stock will need to fall in order for the uncovered put to get exercised and the respective price an investor is compelled to purchase the shares at. The premium is the cash flow the investor will receive from selling a single contract at the respective strike and expiration date. The cost of shares is the cost the investor will incur when compelled to purchase the shares, assuming the stock price is below the strike price upon expiration. As shown in the simple portfolio above, if an investor were to commit to buying 100 shares of each company the total cost would be $9,300. Instead of purchasing shares immediately, an investor could sell puts for $559 and defer their purchase. This represents a 6% return from only selling the puts.

Conclusion

The 2020 presidential election presents an opportunity to speculate on gun stocks. During the 2008 and 2012 election, gun stocks rallied upon the election and re-election of a Democrat. On the other hand, the election of a Republican in 2016 has been bad for gun manufacturers, as gun regulation is not a priority for the Republican party. Therefore, depressed gun manufacturer stocks present an opportunity for investors to speculate on the uncertainty of the 2020 election. We believe selling puts is a great way for investors to gain exposure to these stocks, without outlaying large amounts of capital initially.

Sources:

[1] Gun maker shares rise after Obama re-election

[2] Analysis | Americans spent an estimated $17 billion on ammunition while Obama was president

Disclosure: I am/we are long VSTO, RGR, OLN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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