The document summarizes the American gun manufacturing industry over the past 8 years under President Obama. It finds that while gun ownership has declined overall, background checks for gun purchases more than doubled between 2008-2014, dubbed the "Obama Surge". The top two domestic gun manufacturers, Sturm, Ruger & Co. and Smith & Wesson, increased their market share and saw their stock prices appreciate 12 times over during this period. However, the document predicts consumer demand will taper off as demographics shift away from gun culture, and industry consolidation will likely leave the two top manufacturers as winners in the long run.

1. Page 1
American Gun – 2016
A Survey of the Small Arms Industry

2. Page 2
Introduction
s the Americans anguish over whom to choose in the upcoming
presidential elections, with the rest of the world watching with
trepidation, we take this opportunity to reflect on how the gun
manufacturing sector has changed over the eight years of the Obama
administration.
Guns and with them gun manufacturing and retailing is a highly charged topic.
Everybody seems to have an opinion, but how well do the various commentators
understand the industry? To ground our discussion, we will start by contemplating
the size of the market; putting it in some perspective. We will also look more
closely at who buys guns, where to find them. The demand side of the discussion
will culminate in the reflection on the eight-year surge in gun purchasing, which
we unimaginatively dub the “Obama Surge”.
We then look at the supply side of the story and observe that guns are still “made
in the U.S.A.”, but the story is more interesting than that. Even as the past eight
years have been a uniquely benign environment for the gun manufacturers and
indeed many new entrants were attracted to join the party, not everyone
benefited equally.
We close this survey by speculating about what may lie ahead for the industry. It
is our belief, that regardless of the election results, no regulation will be
implemented to radically change the landscape. That’s not to say, that making
the gun-owning society safer (yes, preventable gun-deaths are worth reducing),
without implementing undue regulatory burden is a bad idea. But fascinating as
it is to observe the NRA marketing machine, the “tyrant Obama” did not manage
to “take anyone’s gun away” and there is a lot of reasons to believe his successor
won’t either.
In the end, we believe, it will be the macro forces of demographics and economics
– not regulation – that will reign supreme. And as we argue here, that’s not good
news for everyone around.
I hope you enjoy reading this survey.
Tom Fencl, CFA
September 11, 2016
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3. Page 3
A Niche Consumer Product Sector
uns are a very special product. For one, they are designed to kill, a feature
other consumer products go into a great length to avoid. Yet, to
understand the industry, one must detach oneself from the mystique and
understand the product for what it really is. While in the past the gun was an
essential tool of making living or ensuring personal safety, its role today has
changed. At a risk of offending some and annoying others, we call it a hobby and
a life-style product.
Before we delve into the consumer gun market, let’s start by comparing it to a
market many may associate more readily with the product – namely the military
and law enforcement branches of the government. Given the media attention,
readers may not be surprised by the fact, that the civilian gun market outranks
the M/L.E. demand. Few, however, realize, just how much bigger the civilian
market is: 120-times bigger.
This staggering number turns out a lot less incongruous, once we consider, that
large as the U.S. military is, its headcount is “only” 1.4 million, which pales in
comparison to approx. 50-100 million gun owners1
. Add to it that majority of the
military personnel has one at most two guns, while many civilian gun owners own
a large number of guns (estimates range 6-8). While gun ownership does not
readily translate into gun purchases, this simple arithmetic is instructive.
The annual gun sales in the U.S. are estimated at $6 Billion, with some 12 million
guns purchased in 2014. Let’s put this in perspective: The Americans spend
annually about $225 Billion on apparel (37x more) and $23 Billion on pet food (4x
more). The consumer category that is comparable is bicycles, with approx. the
same dollar sales, unit volume and household penetration.
1 In the pictogram here, we settle for a factor of 40x to account for L.E. personnel on one side and the
lack of precision on the other.
CIVILIAN GUN MARKET IS 120 TIMES LARGER THAN MILITARY
MILITARY & LAW ENFORCEMENT GUN MARKET
CIVILIAN GUN MARKET
G

4. Page 4
Looking for Gun Buyers
sing the FBI statistics of background checks (known as NICS) as a proxy,
we looked at where in the U.S. are the largest gun markets. As one would
expect, individual states are far from homogenous in terms of their
prevailing attitudes to guns and gun ownership, owing to their diverse history,
geography, demographics and political leanings. This diversity can be measured
by the number of background checks per capita, something we standardized here
by dividing it by the national average (the results for the 20 largest gun markets
are shown on the right-hand chart).
With all the diversity, the 20 largest gun markets are actually predicted by
something more mundane – the state’s population. The top three gun markets
are the three most populous states (albeit California, the most populous state,
thanks to its below average gun demand, drops to a third place) and of the top 20
only 6 are not among the 20 most populous states. This is where Kentucky with
its population of 1.4 million, but almost 4-times the national average of gun
demand, looks eye to eye with New York state, which has the population of 19.8
million, but relative gun demand lower than California.
As a lifestyle product, the gun is (still) a “rich white country man’s hobby”.
According the University of Chicago’s General Social Survey:
 White households are 2x more likely to have a gun than black (39% vs. 18%)
 Households with income $90,000+ are more than 2x more likely to have a
gun than with income <$25,000 (44% vs. 18%)
 The “Gender Gap” (% of men with firearms - % of women with firearms) is
+23%; although here the trend is towards diversity as back in the 1980’s the
gender gap stood at +40%
 Households in rural counties are 3x more likely to have a gun than
households in central cities of the 100 largest Metros (56% vs. 19%)
(Background checks in thousands)
LARGEST GUN MARKETS ARE THE MOST POPULOUSE STATES
0 500 1 000 1 500
Texas
Florida
California
Pennsylvania
Ohio
Tennessee
Missouri
Alabama
Virginia
Indiana
Illinois
Colorado
Washington
Georgia
Oklahoma
Louisiana
Wisconsin
New York
Kentucky
Michigan
0,9
0,9
0,4
1,1
1,0
1,4
1,7
1,9
1,0
1,2
0,6
1,4
1,0
0,7
1,7
1,4
1,0
0,3
3,8
0,5
0,0 1,0 2,0 3,0 4,0
U

5. Page 5
Obama Surge: Why Do Americans All of A Sudden Buy So Many Guns?
ooking at the statistic of household gun ownership (a % of households with
guns) provided by the University of Chicago’s General Social Survey, it is
not difficult to discern the long term trend: Gun ownership is going down.
Back in the late 1970’s, every other household had a gun in it. Today, it is one in
three. The trend in households where one or the other person (or both) hunt has
been similarly downward. Even as the gun continues to play a role in the
American psyche, the society is changing and with urbanization and demographic
diversification, the gun culture is waning.
Yet, between 2008 and 2014, the annual background checks, a measure of
demand for guns, more than doubled. In light of the trend of declining gun
ownership, this mind-boggling "Obama Surge" is perhaps attributable to:
(1) A fear for personal safety, which may bring both new owners to the
market and spur a purchase of an additional gun (a personal defense one,
like a pistol) by an existing owner (of say a hunting rifle).
(2) A fear of losing the right to own or buy more guns, which may pull forward
future purchases or prompt undecided buyer to buy a gun most at risk for
future restrictions, such as MSR, or Modern Sporting Rifle.
The average growth of handguns during the 2008-14 period (15%) outpaced rifle
(12%), which outpaced shotgun (6%) sales, supporting this dual fear explanation.
Also, highly publicized mass shootings – which at their worst (2012: 72) account
for 0.2% of gun-related deaths – predictably drive spikes in purchases. Media
hype aside, we believe this is not a sustainable trend and sooner or later the
demand will taper off, as the reality settles in that neither arming every American
nor recalling all guns is a workable or sensible idea.
(Background checks in millions)
BACKGROUND CHECKS vs. GUN OWNERSHIP & HUNTING TRENDS
0
4
8
12
16
20
24
00%
10%
20%
30%
40%
50%
60%
1977
1980
1982
1984
1985
1987
1988
1989
1990
1991
1993
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Annual NICS % HH w/ Guns % HH Hunting
L

6. Page 6
Bulwark of Domestic Manufacturing
arlier, we compared the gun industry to bicycles, in terms of dollar size, unit
volume and product penetration. There is one important difference. While
99% of bicycles are imported – mainly from China and Taiwan – approx.
70% of guns are manufactured domestically, with the balance being imported
mainly from the EU.
The share of “made in the U.S.A.” guns actually increased during the period, from
approx. 60% in 2008. Yet, partially, due to the increase of the U.S. production
of the leading foreign brands: From a low base, both Glock and SIG Sauer grew
at an average compounded rate of 22%, a double the rate of the market.
The Obama Surge also brought in new manufacturers, more than tripling the
number licensed by the ATF, but the clear winners of the surge have been the two
largest domestic manufacturers – Sturm, Ruger & Co. and Smith & Wesson –
whose combined market share increased from 28% to 34%.
(Pieces in millions)
U.S. FIREARMS PRODUCTION & IMPORTS
(Pieces in millions)
U.S. FIREARMS PRODUCTION & IMPORTS
(%)
U.S. DOMESTIC FIREARMS PRODUCTION SHARE
0
2
4
6
8
10
12
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
3,7
7,70,3
1,0
2,6
3,6
0
2
4
6
8
10
12
14
2008 2014
All U.S. Brands Foreign Brands Imported
14%
14%
20%
44%
8%
19%
15%
16%
40%
10%
RUGER
SMITH & WESSON
REMINGTON
Other US Brands
Foreign Brands
2008
2014
E

7. Page 7
… And Then There Were Two
f the three largest domestic gun manufacturers, only Remington (f.k.a.
Freedom Group) did not capitalize on the Obama Surge. Besieged by
product liability lawsuits and loaded with an LBO debt, its revenue has
been dropping in recent years together with market share and margins.
In the meantime, Sturm, Ruger & Co. and Smith & Wesson have been busy
bolstering market share, investing in modern equipment and expanding their
product portfolio, both organically and through acquisitions. When the demand
tapers off, as inevitably it will, these two market leaders will reap the benefits
of consolidation. As it happened in other maturing consumer markets, retailers
will cull inventory and prune the number of products they carry, paving way to the
leading brands further increasing their share, relying on their brand recognition
and supply chain strength.
($ in millions)
STURM, RUGER & CO.: SALES & GROSS PROFIT MARGIN
($ in millions)
SMITH & WESSON: SALES & GROSS PROFIT MARGIN
($ in millions)
REMINGTON OUTDOOR: SALES & GROSS PROFIT MARGIN
0
200
400
600
800
2008
2009
2010
2011
2012
2013
2014
2015
10%
20%
30%
40%
50%
2008
2009
2010
2011
2012
2013
2014
2015
0
200
400
600
800
2008
2009
2010
2011
2012
2013
2014
2015
10%
20%
30%
40%
50%
2008
2009
2010
2011
2012
2013
2014
2015
0 000
0 400
0 800
1 200
1 600
2008
2009
2010
2011
2012
2013
2014
2015
10%
20%
30%
40%
50%
2008
2009
2010
2011
2012
2013
2014
2015
O

8. Page 8
Along With the Bulls
hareholders of Sturm, Ruger & Co. (NYSE: RGR) and Smith & Wesson
(NASDAQ: SWHC) have had plenty to be happy about. The Obama Surge
in sales and profits aided by the post-2008 Financial Crisis bull market
generated an impressive 12-times share price appreciation for both stocks2
.
They have been for a bit of a bumpy ride during 2014, when demand faltered
following earlier spike post Newtown shooting, but RGR shares are almost back
to 2013 level and SWHC is trading at an all-time high.
Yet the party may not last forever. As Yogi Berra said, predicting is hard,
especially the future, but critical look at the drivers of the share price gains allows
one to glean what may lie ahead. At the end of 2009, the two shares traded at
6.8x and 6.0x of trailing 12 months EPS, humble multiples indeed. By the end of
2013, the multiples were 13.8x and 9.8x, higher, but still modest compared to the
broader market. It’s now, that we are looking at 18x and 13x multiples that we
begin to ask how much future growth there really can be to support such
valuations.
2 Using end of the year 2008 prices (RGR: $5.27 and SWHC: $2.35) as a basis.
($)
SHARE PRICE DEVELOPMENT: RGR vs. SWHC
0,00
10,00
20,00
30,00
40,00
50,00
60,00
70,00
80,00
Q1
'08
Q3
'08
Q1
'09
Q3
'09
Q1
'10
Q3
'10
Q1
'11
Q3
'11
Q1
'12
Q3
'12
Q1
'13
Q3
'13
Q1
'14
Q3
'14
Q1
'15
Q3
'15
Q1
'16
RGR SWHC
S

9. Page 9
What’s Next?
ather than attempting to predict the result of the November election or its
impact on the consumer purchase decisions or stock market sentiment, we
consider the long-term trends and their implication on the dynamics and
structure of the industry in an effort to identify strategic insights and investable
ideas. Following is a list of five such observations:
1. Consumer demand will taper off
Demographics beats media hype. The trends towards urbanization and
diversification will continue to marginalize the gun-shooting lifestyle. The dual
fears that drive the current surge will subside and when they do, the demand will
taper off. Whether this will be a “soft landing” or a dramatic drop akin to the one
experienced in 2014 remains to be seen, but any valuations or business plans
predicated on the growth rates seen during the Obama Surge are due for a
revision.
2. Marginal players will be pushed out of the market as
pressures to consolidate intensify
Retailers worry about one thing, how fast does their stock moves through the
store. When demand is high and growing, they are happy to take on new SKU’s
(stock keeping units) as everything is flying off the shelf. But when the demand
contracts, they will gravitate towards large players with high brand recognition
and manufacturing platform to manage variations in demand.
3. Ruger and Smith & Wesson likely winners, albeit at less
lofty valuations
We believe that the advances Ruger and Smith & Wesson made during the past
years will benefit them as the demand contracts. While they too are unlikely to
sustain the current growth rates, they may be able to preserve much of their sales,
with the consolidation push hurting disproportionately the smaller players. What
they won’t be able to preserve are their current valuation multiples, which require
growth rates (and interest rates) unlikely to be repeated in the coming years.
4. Remington is a dead man walking
With a debt loan exceeding its annual revenue, Remington is ill equipped to
respond to either increased interest rates or lower market demand. If we are right
about the future, both these factors will turn against it. With majority of the debt
maturing in 2019, the time of reckoning will come.
5. Smaller brands will become attractive targets, but
mainstream PE will find it hard to play
While the poster child of the US gun manufacturer consolidation – Remington
Outdoor – does not make the best advertisement, the industrial logic behind it is
principally sound. Pressure to invest in R&D, upgrade manufacturing equipment
and bargain with large retailers all point to consolidation. Many smaller
manufacturers are owned by the first generation of founders, prime targets for an
acquisition. But any PE fund investing pension fund money will be warry to get
into the game after Cerberus’ fiasco with the Freedom Group project.
R

10. Page 10
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