Wednesday, March 11, 2009

Gunning for profits

I've been hankering to write an article on gun manufacturers but a couple of my fellow SeekingAlpha contributors beat me to it. (See this article and this one.) Although I'm rather late to the party, I still want to toss in my two cents for the following two reasons: The first is the fear on the part of the public that the Obama administration will enact tighter gun control laws. The second also springs from a fear-based perception that a further downturn in the economy could fuel an increase in theft and vandalism thus providing impetus to people who want to protect their property.

Smith & Wesson
Of the major manufacturers of firearms only two are publicly traded. The first is the grand-daddy of all of them, Smith & Wesson (SWHC). The company makes everything from pistols to rifles, supporting the entire spectrum of gun owners from hunters to competitive shooters to collectors. It also arms military and security operations worldwide.

According to an article appearing today in Barron's, Wedbush Morgan Securities is maintaining its Buy rating on the company and has raised its target price from $4 to $5. It said that S&W's balance sheet should improve as increasing sales in both the retail and government sectors will help pay down debt while simultaneously reducing inventory. They value the company at a price to earnings ratio of 17.

In another article published yesterday, an analyst at Merriman Curhan Ford said that proposed legislation would target $3.8 billion to better equip law officers. He said that S&W's sales could rise by $47 million to as much as $147 million from the end of this year to the end of 2010 resulting in an earnings boost of 16 cents to 51 cents.

Smith & Wesson's daily chart certainly tells a tale. You can see how the price and volume jumped when the polls projected an Obama win several days before the presidential election. That event halted the steep slide in price and the stock began notching back upward. It broke out of a classic triangle formation on February 20th when Cabela's (CAB), a major retailer in the hunting gear space, exceeded earnings estimates which they attributed principally to a surge in rifle sales. (Note that the chart of Sturm Ruger below exhibits similar parallels.)

The stock continued upwards on much heavier than normal volume and broke the $4 barrier last Friday. Volume has been dropping off in recent days along with price. My recommendation would be to see if the $4 support level holds and to take a position if it turns back up. The next point of major resistance is at $5.

Note that Smith & Wesson will be reporting earnings tomorrow after the close.

Sturm Ruger
The second publicly traded firearm manufacturer is Sturm Ruger (RGR). Its product line is similar to S&W's but its sales are purely domestic. Although sales at S &W are higher than Ruger's ($301 million vs. $181 million in 2008), the latter sports a better balance sheet, at least so far.

After the close on February 24th, the company reported an 81% increase in revenues causing one analyst to upgrade the stock to a Strong Buy. Here's its chart:

The stock has been bouncing between $6 and $7 since December. Following its spectacular earnings announcement, the stock gapped up the next day closing at $9, a 15% increase over the previous day's close. The stock is now sitting near $10 support and a move above recent highs on decent volume would be a buy signal.

Options plays
Note that both stocks have options but S&W's are more liquid. Front-month covered calls could be a good way to bring money into your account while protecting your downside especially if you can write your calls at relative highs. A strong topping tail in either chart has been a tell that a local top has formed.

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