Ruger is seeing weak demand for its products and is slowing down production in response.
Adjusted NICS background checks is a rough proxy for the overall gun market. 2013 was an unusual year with extremely high demand. Q2 2014 saw a drop in adjusted NICS checks versus the previous year (-11.9% year over year).
The other figure is also important as it tries to measure how many Ruger guns are being bought by the consumer. Note that the “Estimated units sold from distributors to retailers” metric is imperfect for the reasons stated in the 10-Q. The numbers:
- Rely on data provided by independent distributors that are not verified by the Company,
- Do not consider potential timing issues within the distribution channel, including goods-in-transit, and
- Do not consider fluctuations in inventory at retail.
Looking at the number of units sold to retailers versus adjusted background checks, Ruger seems to be making small gains in market share if you combine the last two quarters:
- Comparing the last two quarters to the previous year, estimated units sold to retailers have changed -11% versus a -18% change in adjusted NICs checks.
- Comparing the last quarter to the previous year, estimated units sold to retailers have changed -31% versus a -12% change in adjusted NICs checks.
Another way of looking at demand is to look at changes in the company’s backlog (see below). The backlog has dropped to around 2 quarters worth of sales versus 4 quarters in Q1 2013. Units ordered have dropped dramatically. It makes sense for Ruger’s backlog to fall given that it was a little ridiculous to begin with.
I don’t think that too much importance should be placed on Ruger’s backlog. What matters is:
- Inventory levels at the distributors. If they are too low, then distributors may not be restocking retailers promptly. An absence of Ruger products on store shelves will cause lost sales. Conversely, it is bad for distributors if they have too much inventory of Ruger products. Given that Ruger has decided to slow down production, it is likely that distributors have a healthy level of inventory.
- Ultimate demand from consumers. The backlog sometimes has no connection with demand at the retail level. Estimated units sold from distributors to retailers is a better metric for demand.
Reasons for weak demand
The company states in its press release and 10-Q:
- the reduction in overall industry demand,
- the aggressive discounting of many of our competitors, and
- the absence of recent significant new product introductions from the Company.
Ruger has slowed production
Units produced fell 7.7% quarter over quarter.
The 10-Q provides some commentary on the company’s activities:
The Company reviews the estimated sell-through from the independent distributors to retailers semi-monthly in an effort to regulate production and mitigate increases in inventory. As estimated sell-through began to slow, the Company managed its labor force by limiting the hiring of new employees, reducing overtime hours, and allowing attrition to reduce its total employee base. The Company’s compensation structure, under which at least 25% of individual employee compensation was variable in 2013, allows for a more rapid reduction in labor cost.
Capital expenditures have been curtailed by the cancellation or delay of purchase orders and the redeployment of manufacturing equipment from mature production lines to new production lines for products in development.
At the same time however, Ruger will continue to invest in capex:
Capital expenditures for the six months ended June 28, 2014 totaled $22.8 million. In 2014, the Company expects to spend approximately $40 million on capital expenditures to purchase tooling fixtures and equipment for new product introductions and to upgrade and modernize manufacturing equipment. The Company finances, and intends to continue to finance, all of these activities with funds provided by operations and current cash.
The $40M in capex is up from the previous $35M estimate given on Feb 25, 2014 (PDF): “We expect to invest approximately $35 million on capital expenditures during 2014 as we continue to prioritize new product development.”
The level of capex runs slightly higher than D&A, which suggests that the company will be spending money on growth capex. This is in line with what the company is saying about spending money on new products. Because Ruger recently entered into a lease for a new factory (currently at very low utilization), it has the space to increase production. I think that Fifer will look at new product lines with attractive returns. He may be able to make spot highly profitable opportunities even if the overall gun market ends up shrinking. That being said, Ruger is not immune to overall market demand or the forces of competition. Its profitability will be affected by forces outside its control.
*Disclosure: (Unfortunately) I am long RGR.