There are quite a few well-known brands in the U.S. food industry yet few have managed to survive for over 100 years. One example is J.M. Smucker’s (SJM). Another well-known centenarian is Tootsie Roll (TR). In some ways the similarities are remarkable:
(1) TR was started in 1896 and SJM began making jams/jellies in 1897;
(2) both have their roots in the heartland: J.M. Smucker in Orrville, Ohio and Tootsie Roll in Chicago; and
(3) the two companies are incredibly stable.
Given their ability to endure the test of time, let’s look at these two companies through our 5-criteria filter:
(1) Straightforward business, preferably with a repeat purchase model: Both companies manufacture branded food products. J.M. Smucker’s goods are typically sold in the center aisles of supermarkets. Their brands include Jif peanut butter, Crisco shortening/ cooking oil, J.M. Smucker jam and jelly, Pillsbury baking ingredients, and PET evaporated milk. Tootsie Roll’s products are also sold in the aisles and near checkout registers at supermarkets. They are also frequently used as promotional material. Besides their namesake candy, TR manufactures dozens of brands including Andes Mints, Cella’s Cherries, Charms Blow Pops, and Junior Mints. Their business is to manufacture the products and maintain their brand recognition.
(2) Stable business: Having been around for over 100 years, it’s safe to say that both businesses are stable. J.M. Smucker has paid a dividend continuously since 1949 and Tootsie Roll has done the same since 1943. Amazingly, one Tootsie Roll still costs a penny—the same price the candy it sold for in 1896.
(3) Decent balance sheet: Looks good (more on this later).
(4) Top notch management team: J.M. Smucker is still run by the descendants of the original J.M. Smucker. The founding family has operated the company since its inception. Tootsie Roll is run by Melvin and Ellen Gordon. Mr. Gordon has been CEO since 1962. If their ability to endure is any indication of their competence, both companies are in good hands.
(5) Industry leadership: Given their strong brand recognition, both companies are leaders in their respective markets.
Since both companies are successful, operate in good, stable businesses and have strong management, let’s try to understand if this translates to a reasonable financial margin of safety by looking at 7 valuation-oriented parameters.
Margin of Safety
Margin of safety affords the business owner room for error if things go wrong. Companies with a good margin of safety are on stable ground and can be expected to withstand unforeseen difficulties. In practical terms, this means the company can continue to pay its bills while it works through issues. The following 7 data are provided for TR, with SJM’s values in parentheses:
- Price to book: 2.11 (SJM is 1.34)
- Cash on hand: $55 million or $1.55/share (SJM has $200 million or $3.60/share)
- Annual cash flow: $1.31/share (SJM has $4.04/share)
- %LTD/capitalization: TR has no long-term debt (SJM’s is 17.9%)
- Price to earnings: 25.2 (SJM’s P/E is 14.6)
- Common stock dividend yield: 1.27% (SJM’s dividend yield is 2.65%)
- Revenue growth (since 2004): 18.1% (SJM: 56.8%)
Margin of safety appears to be decent for both companies. Despite their age, both companies continue to grow revenue. For the most part, they have expanded their footprint by acquiring new brands. TR purchased Concord Confections, a Canadian candy maker, in 2004. SJM expanded its business by purchasing White Lily (flour and cornmeal) in 2006 and Eagle Family Foods (condensed milk) in 2007 while divesting Brazilian operations in 2004 and Canadian operations in 2005 (to Cargill). To summarize their businesses at a very high level:
- Very narrowly focused product base (confectionery products)
- US, Canada and Mexico exposure; negligible exposure outside North America
- Sensitive to raw materials and supply chain costs
- Focused products, primarily dealing with food preparation; some ready to eat foods
- US and Canada exposure; limited exposure outside North America
- Sensitive to raw materials and supply chain costs
Given that margin of safety is acceptable, which company is better? It appears to be a mixed bag. Even though they carry no debt, Tootsie Roll’s P/E is quite a bit higher than SJM’s. Still, both companies have steady, positive cash flow. Perhaps the hallmark of value investing, intrinsic value, can help us find out.
Intrinsic value has been defined as how much cash can be taken out of each company during its remaining life—a powerful way to measure the value of owning a company. For simplicity, let’s use an equation borrowed from Warren Buffett’s mentor, Ben Graham:
Intrinsic Value = EPS * (2r + 8.5) * 4.4/γ
EPS = Trailing 12 months earnings per share r = Expected earnings growth rate γ = Yield on AAA-rated corporate bonds
Based on this, I estimate Tootsie Roll’s intrinsic value at about $6/share (recent stock price is $25.25). Similarly, J.M. Smucker’s estimated intrinsic value is about $46.80/share (recent price is $45.72). This is a significant point of differentiation. Tootsie Roll is priced significantly above its intrinsic value while J.M. Smucker is priced at very close to its intrinsic value. How can this be? The two key variables used to calculate intrinsic value are:
(1) trailing 12 months EPS, and
(2) expected earnings per share [EPS] growth rate.
The former is straightforward enough: Current [TTM] EPS is $1.01/share and $3.04/share, for TR and SJM, respectively. The latter (expected earnings growth) is an entirely different story.
Profitability is Key
Expected earnings growth hinges on a company’s ability to either increase top line (sales), reduce costs, or a combination of the two. Looking at the last five years, TR has had flat earnings, so my expected earnings growth rate is 0%. In fact, indications are that earnings growth will be negative in the near future due to exchange rate-related cost pressures arising from production at their Canadian facilities. On the other hand, J.M. Smucker’s earnings have been growing more steadily. Their 2003 EPS was $2.02/share and current [TTM] EPS is $3.04, which means that EPS, up 50% in four years, is growing at about 11% per year. To be conservative, I’ve estimated earnings growth at 8% to arrive at the intrinsic value figure above.
It’s a Jungle Out There
Business is tough: without adequate growth in revenue, costs eventually eat away at profitability, diminishing value for owners (shareholders). Failure to sufficiently grow revenue, in light of cost increases due to energy, raw materials and foreign exchange fluctuations, can take a hefty toll. J.M. Smucker has been able to negotiate these troubled waters by investing carefully in the growth of their business, avoiding excess debt, and paring non-value adding operations. In contrast, it appears Tootsie Roll is struggling to grow their business enough to also increase earnings. The good news is that they have available cash and no debt to help grow the business. If they fail to do this, someone else may seize on the opportunity.
Disclosure: The author has no positions in TR or SJM.