Description

This will be a short and timely report.  We debated posting this before VSTO's results this morning, which we expected to be weak, but had lower conviction in that share reaction (given the recent sell-off) so held off.  RGR is indicating down 1.1% pre-market, which would be a gift and a great opportunity to enter this short.

Long story short: if after the worst mass shooting in history, there was ZERO bump to gun sales (d.t. being in a Republican presidency), it's unlikely we'll see any surges in the next four years.  RGR (and AOBC) have massive fixed cost leverage which will take time to right-size.  In the meantime, merchants are over-inventoried (see VSTO this morning) and are not ordering guns from RGR.

Industry

·        Adjusted NICS checks, the best proxy for firearms demand, declined 17.0% in October, with 2yr and 3yr stacked growth decelerating and remaining negative. That suggests industry demand remains sluggish heading for the important hunting selling season. NICS comparisons will become more difficult in November as the industry a final purchase surge ahead of the Nov 16 election.

·        The October NICS check coupled with the difficult November comparison suggests industry demand for 4Q17 is likely to be down 17% or more.

Crux of the thesis:

·         RGR’s sales are driven by 1) end market demand and, 2) inventory levels of distributors

1.       RGR publishes end market sales by its distributors which has a very high correlation to NICS checks and have recently been lagging NICS checks due to increased discounting by competitors. With NICS expected to be down 17% in 4Q17, end market sales by RGR’s distributors is likely to be down even more.

2.       RGR’s distributors ended 3Q17 with 363,800 units of inventory. That represents 4.9x inventory turns. Distributor inventory is considered healthy at turns above 6x, meaning RGR’s distributors need to de-stock their inventory levels by selling more product than they buy from RGR. With end-market demand for distributors expected down more than 17% and a destock of approximately 100,000 units required to distributor inventory to normalized levels, RGR’s units shipped in 4Q17 needs to decline by at least 40%.

  Gross margin

·         RGR’s fixed cost model means a 40% revenue decline is likely to cause a cost per unit of at least $215. The real cost per unit is likely to be as high as $225.

·       

Earnings/EPS

·         Below gross margin RGR’s cost base is small and mostly fixed. The flow of the revenue and gross margin miss will result in net income below $5m and EPS below 30c. Consensus models net income $13.6m and EPS 77c.

·         The stock trades at 19x 17 EPS of $2.59 vs. a prior Republican-president average multiple of 11x.

Conclusion

This Bloomberg article illustrates the point quite well: https://www.bloomberg.com/graphics/2017-gun-sales-in-america-stopped-spiking-after-mass-shootings/ 

RGR's stock went up +570% during Obama's eight year era, where no meaningful gun reform actually happened.  Now we have a Republican government, and despite increasingly horrifying mass shootings, nothing will be done either.  Therefore no spikes.  Guns are a durable good, so the large build-up of guns (unconfirmed, but I heard Americans own 40-60% of all guns in the world?) means we could be approaching saturation.  

RGR's stock is down (23%) since Trump's election.  We think there's a lot more to go. 

Catalyst

NICS, VSTO earnings, AOBC earnings, and finally an awful RGR earnings miss.