Though gun sales have skyrocketed on fears about new restrictions, gunmaker stocks may be suggesting that the market is close to peaking.
Demand for firearms has been so strong over the past year that manufacturers have been running their plants at near capacity to keep up. That has translated into big increases in sales and earnings for companies such as Smith & Wesson (SWHC) and Sturm Ruger (RGR), but their stocks have lacked pop this year after a hot run in 2012.
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Smith & Wesson shares are up 3 percent so far in 2013, well off the nearly 10 percent gain for the small-cap Russell 2000 (NYSEArca:.RUT-P), while Sturm Ruger is up 10 percent.
Sales trends have been smoking. During the first three months of the year, background checks run through the National Instant Criminal Background Check System rose 44 percent from a year earlier. The data suggest strong demand, though not all background checks lead to a purchase.
Freedom Group, one of the largest firearms makers in the U.S., stated in its annual filing that "the concern over more restrictive governmental regulation on the federal, state and local levels have partly contributed to this increase; however, the industry is continuing to experience a long-term overall growth rate" given the growing popularity of shooting sports.
The growth in demand began well before recent efforts to restrict gun purchases, according to Rommel Dionisio, an analyst at Wedbush Securities.
"The surge began last year," he said. "It really started in December 2011 and accelerated through 2012."
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Strong Start in 2013
Demand for firearms is stoking nearly 40 percent sales growth at both Smith & Wesson and Sturm Ruger. The latter said its first-quarter earnings rose 53 percent, driven in part by a 39 percent sales increase. To keep up, the company is planning $30 million in capital expenditures this year.
Smith & Wesson is also having trouble meeting demand. In its quarterly earnings press release, the company said it continues to boost production and has operated at essentially full capacity for the past four quarters.
"Despite these capacity increases, the company was unable to meet the ongoing demand across all of its firearm product lines," Smith & Wesson said.
For the quarter ending Jan. 31, Smith & Wesson reported a nearly 39 percent rise in net sales. It expects full-year sales growth of 40 percent.
One reason for the stocks' lackluster performance is that Wall Street is starting to think about when that tide will turn.
Any talk about gun-control measures has motivated consumers and driven purchases, Dionisio said. "The weakness in the stocks reflects concern that this is going to come to an end sometime soon," he said.
There's also a limit to how many more firearms people will buy, given already-high gun ownership rates. According to a December Gallup poll, 43 percent of Americans have a gun in their homes, versus 39 percent in 2010.
The National Rifle Association, which begins its annual meeting Friday, estimates that there are nearly 300 million privately owned firearms in the U.S., up by about 120 million since the 1990s.
Dionisio, who covers Smith & Wesson, has a neutral rating on the stock and said that while it trades at a discount to its historical average, concern is growing that recent sales boom has peaked.
Sporting Goods Retailers a Better Option?
Shares of sporting goods retailer Cabela's (CAB) have been a massively better performer than the manufacturers so far this year. The stock is up nearly 50 percent as it benefits from the boom in sales of firearms and ammunition.
Cabela's posted a 24 percent increase in same-store sales in the first quarter; revenue jumped 29 percent. Excluding firearms and ammunition, comp store sales were up just 9 percent, the company said.
Dick's Sporting Goods (DKS) is also a leading retailer of firearms and ammo, which Barclays analyst Alan Rifkin estimates account for about 5 percent to 10 percent of total sales.
"While the hunting and firearms category continues to perform well-with sales up 5 percent annually (on average) between 2008 and 2012-Dick's faces significant headline risk given the controversy surrounding this category," Rifkin wrote in a research note.
He initiated coverage on Dick's stock this week with an outperform rating, nonetheless, given opportunities for store growth, e-commerce and greater private label penetration. His price target of $57 implies nearly 19 percent upside.
With its diversified business, Rifkin said, Dick's can lean on other sporting goods categories when the firearms boom fizzles.
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