Tootsie Roll Industries, Inc. (NYSE: TR): $500+ million in annual sales, conservatively financed, consistent and ethical management, and the manufacturer of some of the worlds favorite candies. By all appearances, this company is one sweet value investment, but looks can be deceiving.
Is the company truly a sweet deal or will it leave a sour taste in your mouth? As Mr. Owl would say... "let's find out".
Tootsie Roll Industries Inc.
The company has been making its namesake candy since 1896 and has expanded its line of confections along the way. Dots, Junior Mints, Andes Mints, Blow Pops and Sugar Daddies have turned this simple candy company into a confectionery empire with over $536.6 million worth of product sales in 2015 alone. That's a lot of candy!
The Value Side
I see why people may consider this company to be a value investment. The products it produces are relatively simple. Sure, technology has changed over time, but the recipe and method for making Tootsie Rolls hasn't really changed in the past 100+ years.
The company has strong brand name recognition, very little debt, strong cash reserves, has been paying a dividend every year for over 70 years, and has given investors a special stock dividend every year for over 50 years.
Couple these facts with a management team that has strong ethical convictions, doesn't have any stock-based compensation programs, and whose Board holds significant equity stakes in the company and it's easy to see how this company could make the value investment list.
The Bitter Side Of A Sweet Company
The bitter taste in your mouth probably starts with the company's growth prospects. We're talking about a company that's almost 120 years old; its growth days are likely well behind it.
The first quarter of 2016 saw sales of $103.362 million. This was actually down from the $105.477 million in sales the company had in the first quarter of 2015.
Looking at a little wider time frame, we see sales for the past five years as follows:
- $536.692 million in 2015
- $539.895 million in 2014
- $539.627 million in 2013
- $545.985 million in 2012
- $528.369 million in 2011
While this is impressive, especially considering it sells candy, it also confirms that annual sales aren't likely to grow in any material way. It doesn't mean that it can't grow sales, just that it's not very likely.
The good news on the sales front is that we can realistically expect the company to have annual sales of $525 million to $550 million based on its performance from the past several years.
Stable sales can sometimes be preferred to growing sales, especially if the company is able to widen margins and significantly increase earnings.
Berkshire Hathaway Inc. (NYSE: BRK.A) (NYSE:BRK.B) is the perfect example. The company's growth has slowed substantially over the past few years. The company grew so large it was simply unrealistic to expect that kind of growth to continue indefinitely, yet its Class A stock trades at over $212,000 a share because the company is so well managed.
The story is a little different when your margin starts at a depressing 8.3%. Sadly, this was the situation the company faced back in 2011.
Raw material cost had been on the rise and many confectioners were switching to cheaper, and often inferior, raw materials, but management for Tootsie Roll Industries refused to produce an inferior product. I can commend them for that choice, but it still hurt margins significantly.
Since then the company has been able to grow its margins from that 8.3% in 2011 to 12.3% in 2015. Hopefully, this trend will continue and we will see 12.3% become 15-16% in the next few years, but that may not happen.
Management has made their stance on quality ingredients clear. Should materials cost see a significant price increase in the future, history would likely repeat itself; margins would get crushed, and it would start the cycle of trying to grow margins all over again. I think this is almost certain to happen eventually as long as mother nature is involved.
Sweet, Sweet Sugar
I took a little deeper look at the issue of materials cost and focused on sugar. The company does have hedging operations to hopefully help in the case of a sudden spike in materials cost. As we've seen sometimes, those operations fall short, as was the case in 2011.
The team over at TradingEconomics.com has some great interactive charts for different commodities. Technical analysis aside, these charts are great for learning a lot about a commodity's trading history in a very short amount of time.
Using their interactive sugar chart, I was able to clearly see where the price of sugar spiked in 2010 and 2011. With their interactive cocoa chart, I see the same thing; elevated prices in 2011 which were at, or near, a 10-year high.
Mother nature isn't going to change. There will still be hurricanes and natural disasters. There will still be strange weather patterns, droughts, and bad years for crops.
Since the company relies on these, and other, crops for its raw materials, I expect for there to be times when the prices of these raw materials spike to multi-year highs. These costs could increase for any number of reasons. I just expect mother nature to be the most predictably unpredictable.
The Game of Risk
Sometimes it's hard to imagine all the risks that a company could face. What would happen if a hurricane led to a low supply of cane sugar this year? What if a child eats a piece of candy that has metal shards in it from faulty equipment?
The annual sales and margins the company produced last year seem good for now. What if any of these, or a thousand other things, completely derail the company next year? Could such an iconic company actually face a risk so great it could completely bankrupt the company?
Yes, and it has happened before.
Buying Opportunity Vs. Disaster
There's a difference between having a buying opportunity because something bad happens to a great company which will hurt it temporarily, and a true disaster that may wipe out the entire company.
Tootsie Roll Industries is in a great position to face a number of risks without facing the possibility of insolvency. The company has grown its working capital to $221.744 million, adding to the number substantially in each of the last four years.
The company is conservatively financed with only $7.5 million in long-term debt via its industrial development bonds. Add to that $126.145 million of cash and equivalents, almost $49 million in accounts receivable, inventory valued at over $62 million, and over $800 million worth of property such as real estate and equipment. It would be easy to make the case that there's nothing that could take this company down.
Unfortunately, the biggest liability the company faces is also one of its most valuable assets: Its employees.
History On Repeat
The company employs approximately 2,000 people, many of which are members of the Bakery, Confectionery, Tobacco Workers and Grain Millers Union.
THE SAME UNION THAT BROKE HOSTESS!
I'm not saying I agree or disagree with the idea of a union. That is a different subject for a different time. My point is to look at what this particular union has done in the past.
In 2012, Hostess was in trouble. The company had filed for bankruptcy protection almost a decade earlier, and then had to file again a few years later. The company was taken private and the employees/union were given a substantial equity stake.
In 2012, Hostess' management went to the union, the same one that employees of Tootsie Roll Industries belong to, and presented a plan that may have allowed the company to limp along. Yes, the plan called for cost cuts, including salaries, wages, pensions, health benefits and other things that unions and their members like to complain about.
Management explained to them that if this doesn't happen, then the company is out of business. Period.
92% of the union workers voted against the proposal. I remember watching it play out in live action because I was stunned. I was stunned because almost instantly the executive team shut down the company.
18,000+ jobs lost. The entire workforce was now unemployed.
What stunned me most was that the employees who voted against the proposal that would have kept the company operating and kept their paychecks coming, acted like they had no idea the company was actually going to close down; no idea they were going to lose their jobs.
They were CLEARLY warned what would happen if the proposal didn't get accepted, yet they acted like someone hit them with a brick wall.
Clearly, the company had bigger problems than just this one proposal getting voted down. The story of how all of this came about involves more people and events than just these few actions, but the union even made a press release that stated:
"Our members knew that the massive wage and benefit concessions the company was demanding would go straight to Wall Street investors and not back into the company".
It was a privately owned entity that was 50% owned by the employees. It wasn't a publicly traded company. The people who voted to destroy the company were the shareholders!
I understand there are vast differences between Tootsie Roll Industries and Hostess. One was in horrible trouble and had been for almost a decade with virtually no hope or path to long-term success, and the other is the opposite which is well run, has consistent profits and has a great management team that has been in place for almost half a century.
My motto is to never underestimate the ability of people to do the stupidest thing at the worst possible time. That's what worries me about Tootsie Roll Industries, and my fears may not be unfounded.
The company's union contract is set to expire in the third quarter of 2017, but that's not the real issue. The problem is that Tootsie Roll Industries is involved with a pension plan associated with the union.
Tootsie Roll Industries contributes to a pension plan for its union workers. Other companies whose employees belong to the same union also contribute to this plan.
To put it lightly, this pension plan is in danger of insolvency.
Reading the 2015 annual report sections that deal with this subject, I feel that I'm having to read between the lines a little. The report mentions several things that are happening with this situation and several things that could happen, but I can't help feeling it isn't coming out and saying what it wants to say.
It seems that the company is currently paying more than usual to try and get the pension fund into better shape, which it is likely required to do until its union contract expires in late 2017.
Where it gets interesting is when the company mentions the option of exiting its participation in this pension fund. Apparently, that is an option. It would still be required to make payments, likely for the next 20 years, but it could result in it spending less by getting out.
If it used this option it seems its cost to do so, over a 20-year period, would be roughly $60 million. This figure may be reducible to somewhere in the area of $45 million depending on how a few things play out; either way that's about 75%-100% of what the company is currently making a year.
It seems odd that it has stayed in this long. The annual report states that if the company had chosen to part with the pension fund program over the past several years, the cost to do so would have been lower, significantly lower when figured over a 20-year period.
There's something in the way that it's written that makes this subject stand out from the rest of the annual report. It seemed more fuzzy. More legal speak deliberately placed in sections regarding the pension fund program.
It almost gave me the impression that the company really wants to stop being a part of this pension fund, that it would be willing to make payments for 20 years if it had to as long as it could get out, because it's just a giant mess and a headache, but that it's afraid if it uses that option when its union contract expires, there may be some sort of retaliation by the union.
It didn't come out and say that of course. It didn't say we're afraid if we exit this pension program, the union will be hard to deal with when we need to renew our contract in 2017. It didn't say it was afraid the union would organize a strike. It's just the impression that I got the moment I read through that particular part of the annual report. The company even says it doesn't know exactly how this will play out, so I won't act like I do.
What I do know is that it's a bad situation for everyone involved and there doesn't seem to be a good option. Just a few options that may be less bad than others. When your least bad option would likely cost you about a year's worth of profits, I want no part of it.
The Valuation Problem
Even if you consider the company a winner, the stock isn't for several very important reasons.
The first thing we need to do is look at the current stock price. Even a great company can be a horrible investment, if you pay too much.
As of this writing, the stock is trading at $35.15 a share.
The company has paid a cash dividend each and every year for the past 73 years. That's pretty amazing until you realize the dividend is a joke.
In 2015, the annual cash dividend was $0.35 cents. Thirty-five cents. For the entire year. That's less than the cost of a postage stamp.
Even better, it's paid quarterly. Less than a dime every three months.
That's actually more than on average because for the past 10 years or so, the dividend has only been $0.32 cents a year.
In 2012, investors made out like bandits. Not only did they get their normal $0.32 cent dividend but they also got a special one-time $0.50 cent dividend on top of that.
If you bought 1 share today, and saved your dividends for roughly 18 years, you could take your dividends and go buy a 400 count bag of tootsie rolls for $6.27, assuming no taxes on the dividends and no sales tax.
That's a 0.98% yearly return on investment. At that rate, it would take just over 100 years to recoup your initial investment from the cash dividends. To call that a value investment is a disgrace.
For 51 years now, the company has also treated its investors to a special stock dividend once a year.
Once a year, the company "gives" investors stock equivalent to 3% of their stock position. So if you own 100 shares of Tootsie Roll Industries and the company declares a stock dividend, you will end up owning a total of 103 shares.
Some people, especially management, use this "stock dividend" as justification for the ridiculously small cash dividend. This is simply unacceptable.
It's not a "stock dividend", it's a stock split. You can call it what you want, you can dress it or fancy it up; in the end, it's a yearly stock split. It dilutes your ownership in the company each and every year.
Worse yet, the true value/current stock price of any shares you are "given" can only be realized if they are sold. In order to sell the stock, you would have to pay trading fees and any taxes that fit your circumstances.
The vast majority of people aren't going to do that. It's not feasible or realistic. You would have to own several thousand shares for that to even be considered feasible every year.
What that means is that you are really receiving a 3% increase in your future horrible cash dividend stream of income, with the added benefit of being able to cash out the stock price at some date much further down the road when you decide to liquidate your entire position.
As you can see, I am not a fan of the yearly stock split... I mean "stock dividend", nor am I a fan of the stock buybacks.
You may be wondering how I could dislike both a stock split/stock dividend and a stock buyback. It seems rather contradictory to not be a fan of either.
The company has no formal stock buyback plan. There is no outline, no certain amount set aside for buybacks. It's just done whenever management feels that it's a good idea.
Since the company doesn't have any stock-based compensation programs or incentives for management, this should be a good thing. Where a stock split dilutes investors' ownership, a buyback should increase that ownership.
My problem with the company's rather consistent willingness to buy back its stock is that it only partially offsets the stock split/stock dividend every year.
Closer Look At Stock Dividend/Buybacks
This whole 3% "stock dividend" mixed with stock buybacks deserves a much closer look. On page 37 of the company's 2015 annual report, there is a very interesting breakdown of this activity worth looking at.
From this table, we can see that there are two different types of stock, common stock and class B common stock. In addition, the table lists Treasury stock. Forget the dollar amounts and focus on just the number of shares for each category.
January 1, 2013:
- 36,649,000 Common Shares
- 21,627,000 Class B Common Shares
- 73,000 Treasury Stock Shares
58,276,000 shares (common and class B common) + 73,000 Treasury stock = 58,349,000 total shares
3% "stock dividend": 1,095,000 common shares issued, 648,000 class B common shares issued, 3,000 shares Treasury stock issued.
Total shares issued: 1,746,000 shares
19,000 shares class B common converted to 19,000 shares common stock (1 for 1 conversion)
Purchase and Retirement of Common Shares: 752,000 Shares Common Stock.
Stop here for a moment and notice something important. When the company has its 3% "stock dividend", it applies to common shares, class B common shares and Treasury stock, but when it buys back shares it is only buying back common shares.
It is also buying back more common shares than it is issuing in class B common shares.
In 2014, it issued 1,099,000 common shares and buy back 861,000 common shares. In 2015, it issued 1,112,000 common shares and buy back 1,047,000 common shares.
So each year, in recent history anyway, the 3% stock dividend is issued across the board, and then the company buys back common stock in bulk, but never enough to fully cover the amount it just issued.
At the same time, class B common stock is being issued and Treasury stock is being issued, but these aren't part of the buybacks.
Why All This Trouble?
The beauty of these shenanigans is in the details. Class B common stock has superior voting rights to common stock.
The 3% "stock dividend" increases the number of shares in each class that are outstanding each year. The buybacks help mitigate this for the common stock, but are not adequate to fully offset the number of common shares issued.
The result is that common stockholders have a slightly diluted position. Class B common stockholders have a much more diluted position but with far superior voting rights.
In the end, these programs make sure that each year the number of shares with superior voting rights continues to grow at a rate much faster than the growth of shares with inferior voting rights.
So who owns the majority of the class B common stock with superior voting rights? The President and CEO of the company.
Ellen R. Gordon
Ellen R. Gordon, President and CEO of Tootsie Roll Industries Inc., owns or controls an impressive amount of the company's stock.
According to the latest Form 4, which Mrs. Gordon filed with the SEC on 12-16-2014:
Between her, her kids, her kids' trust fund, her spouse, and their charitable trust, she owns or controls a total of 18,458,969 shares of the company's common stock and 18,819,947 of the company's class B common stock.
Suddenly things become much more clear. A total of 37,278,916 shares that pay a dividend of $0.35 cents per share means that they reap $13,047,620.60 a year just from the tiny cash dividend.
That's also the reason the dividend is highly unlikely to increase by any significant amount. They own so many shares that a horrible cash dividend ends up paying them over $13 million a year.
The 3% "stock dividend" keeps their superior class B common stock growing at a faster rate than the inferior common stock so that they never have to worry about voting power.
There's only a total of 37,382,000 common stock shares outstanding and 23,542,000 class B common stock shares outstanding.
That means that her and her family own 49.379% of the company's common stock and an astounding 79.942% of the company's class B common stock.
This might as well be a privately held company.
What This Means For You
The cash dividend isn't going to increase much, if at all. If $0.35 a share is making the company's biggest shareholder over $13 million a year, why would it raise the dividend payout?
They've held these shares for decades. It has made them rich dozens of times over. Their dividends are worth more than a million dollars a month.
If it raises the dividend, then they have to pay taxes on the additional dividends they receive. If it instead keeps those additional funds in the company, they don't have to pay any additional taxes.
Either way they get to control and do with the money what they want. By keeping the dividend per share extremely low, they get to avoid some taxes while still controlling the money.
With the yearly 3% "stock dividend", they get to increase their dividend payments by several hundred thousand dollars a year, avoid paying taxes on most of their gains, and they get to expand their voting power.
This is also the reason the company won't be sold. They don't want to be taken over. The company is a family legacy and their own personal money tree. It has made them rich for decades and will continue to do so for years to come. If investors are waiting for the company to be sold to a competitor, they are going to be waiting for a very long time.
It would be easy to consider Tootsie Roll Industries as a value investment. The company is very likely to keep having annual sales of $525 million to $550 million. The company is very likely to keep making $60 million to $65 million a year, year after year.
Unfortunately, with stagnant sales and earnings, the company is not likely to have the kind of organic growth that would be needed to justify holding the stock in hopes of an appreciating stock price.
The miniscule cash dividend is horrible for just about anyone other than the Gordon family.
Even worse, there are probably a lot of people out there who thought they really found something special because the company has a 3% yearly "stock dividend", blissfully ignorant to the fact that this tactic only serves to increase the Gordon family's voting control of the company while simultaneously insuring that unsuspecting investors slowly lose what little voting power they have.
While Tootsie Roll Industries is in many ways a great example of what a value investment is all about, it's also a prime example of how buying stock at a horrible price in a great company can destroy the potential of your portfolio.
What To Look Forward To
At over $35 per share, this company shouldn't even be on most investors watch list, but there is hope.
The stock is likely to decline as investors realize that the Gordon family has no interest in selling the company. How far the price will fall, and when, is yet to be seen.
I will probably never see the day when the market overreacts, and I have a chance to load up on this stock at under $5 a share. If that does happen, I will be begging, borrowing and stealing to get my hands on each and every share I can, but until then I'm not a buyer.
I think there may be a potential arbitrage opportunity with this stock, but that is beyond the scope of this article and is not guaranteed to succeed.
If you own this stock and have made money on the position, I encourage you to strongly consider somehow locking in your profits. At least take the time to sit back and look at your goals. Consider whether or not this stock truly deserves a future in your portfolio.
So, how many licks does it take to get to the cash filled center of Tootsie Roll Industries Inc.? As long as the Gordon family owns the massive majority, the world will never know.
The Tootsie Roll Industries Inc. 2015 annual report, first quarter 2016 quarterly report, as well as other filings made by the company and referenced in this article, can be found at tootsie.com/financials/. Other information regarding the company can be found on other parts of this website.
Some information used in this article, including parts dealing with beneficial ownership, were located through the sec.gov website. Specifically, Form 4 filed 12-16-2014 regarding ownership by Ellen R. Gordon.
Who's to Blame for the Hostess Bankruptcy: Wall Street, Unions, or Carbs? by Jordan Weissmann, Published 11-16-2012 via The Atlantic, was extremely helpful to the creation of this article and can be found by following the link to the article in the section on Hostess.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.