Tootsie Roll Industries (NYSE:TR) has experienced a revenue and sales plateau. The main reason for this is a management's lack of interest in taking a more aggressive approach in terms of a more than needed M&A strategy. This lack of interest is clearly reflected in the fact that the company spends all of its surpluses on paying dividends and buying back shares indefinitely while maintaining a virtually nonexistent debt.
All directors and executive officers own a whopping ~55% of common outstanding shares, and ~83% of class B outstanding shares. Although high insider ownership is often associated with management's commitment to reward shareholders in the long run, this is not the case. The lack of changes in operations and structures of the company over many years suggests that the management is accommodated in its position as long term shareholders. For this reason, I believe that the company will remain stagnant unless there are significant changes in management's attitude. In short, an investment based on the hope that management will change its mindset is not the best idea considering the opportunities we have in the market today.
Founded in 1896, Tootsie Roll Industries is a major American confectionary company. More than a century has passed since Leo Hirschfield started to sell candies for one penny, when Tootsie Rolls orders were still delivered by horse. Can you recall where were you by then?
Image source: Tootsie Rolls Industries website
Well, today the company operates in more than 75 countries worldwide, employing more than 2,000 people. Its main manufacturing, warehousing, and distribution center is located in Chicago, Illinois, but also operates in other buildings in Tennessee, Delavan, Cambridge, Ontario, Hazleton, Barcelona, and Mexico City.
But the Tootsie empire does not end here. The company has been expanding outside its borders, acquiring throughout its history various companies that were once a strong competition. Within the list of subsidiaries that today are part of Tootsie, we have The American Candy Company, a traditional confectioner that was born in 1899, and Fleer Española, which is a Spanish based small subsidiary that produces Clix and Dubble Bubble gums, two brands that cannot miss next to the cash registers of small convenience supermarkets that fill the streets throughout Spain. But the list does not just end here, among the different subsidiaries that surround Tootsie, we can find Charms LLC, Cambridge Brands Manufacturing, Concord Confections, among others. These companies have something in common: they, produce, package, and sell candies that have been the favorites of many for many generations.
Image source: Tootsie Roll Industries website
Candy is not just a child's thing, think of Fisherman's Friend, a very old-fashioned United Kingdom's candy brand produced by Lofthouse of Fleetwood, famous for the intensity of flavors of its products, that has been sold since 1865 when the pharmacist James Lofthouse developed it for respiratory problems relieve.
The company's revenue has been stagnant for many years. This has been caused, in part, by a lack of acquisitions and innovation. The last acquisition made by the company was Concord Confections in 2004. Since then, the company has constantly been adding new flavors to its portfolio of brands. In the long term, it is necessary for the company to expand beyond its lifelong brands for revenues to see steady increases again, towards new types of products that better respond to changing trends in children and not so children. For this reason, the company clarified in the last annual report that they are looking for potential acquisitions.
Over the past few years, Tootsie has been increasing its dividend little by little, usually maintaining a 0.90% to 1.25% dividend yield. From 2014 to 2020, the dividend increased at a 4.2% CAGR, slowing since 2018. Such slow growth of the dividend considering that shareholders get a ~1.1% yield of at the time of purchase plus a fixed 3% stock dividend, makes me consider that the shares are very expensive for those looking for dividend growth, since the company has been doing so at the expense of not increasing sales. The reason why the dividend has grown so slowly from 2018 has been the difficulty that management has found in increasing sales.
With a free cash flow to equity of $79.59M and a dividend expense of $23.46M, the company can amply cover the dividend without blinking too much. The management has usually kept a very conservative approach regarding dividends, and it has not increased them until the balance sheet has made it possible without compromising the future of the company. Furthermore, the company's $106.29M cash on hands ensures the viability of the company during the coronavirus pandemic and its resilience in front of any headwind in the medium term.
|Net product sales||$539.90M||$536.69M||$517.37M||$515.67M||$515.25M||$523.62M|
During the three months ended on June 30, 2020, the company reported a sales decline of 24.74% from $ 106.02M to $79.77M, but if we take the whole semester, the company only reported a sales decline of 11.80%, which suggests that the large decline in sales throughout 2020 is mostly due to the current coronavirus pandemic crisis. This means new lockdowns stemming from second waves could continue to hurt sales throughout the second half of 2020. In the last decade, the company has failed to increase sales, and has not taken action on the matter yet, apart from launching new flavors in its different products and reinforcing the presence on social media. At this stage, I believe the company can't increase sales without looking at the competition in search of potential acquisitions.
During the last decade, Tootsie has been enjoying a desirable ~32-37% gross profit margin. This means that the company currently makes 37.11% from its products after the cost of goods sold has been deducted. In this sense, we can say that the company is quite profitable. So, there must be some other reason why it remains stagnant, like a walking turtle, walking a safe path thanks to its great experience and wisdom, weighed down by lack of motivation after so many years walking. A good profit margin makes me wonder what prevents the company from jumping into the world again in search of new candidates to be part of its product empire. The first thing I would look at in such a situation is the level of leverage the company possesses, looking to see if the interest expenses eat up a large part of the benefits, but that is not the case in Tootsie Roll.
It seems like this lack of debt is what mostly maintained the share price close to all-time highs, since the company has no interest expenses for which to take responsibility, so the risk is very low. This vastly reduces the risk of the company being unable to meet its obligations if it finds a headwind at some point, but it carries a different risk, one that would concern me even more as a shareholder: the lack of dynamism. The company is constantly missing the opportunity to use leverage to acquire new companies and brands, which could help it not only to increase sales, but also to keep itself adapted to the constant changes in consumer demands. In this sense, I think it is riskier to sit idly by rather than go to the market and take advantage of the good health of the balance sheet to add new armies to the Tootsie empire, taking advantage of the wonders of a smart use of leverage.
Throughout history, Tootsie Roll has been a stock repurchaser without a rest. Buying back shares is a way of rewarding the shareholders of a company, since by reducing the number of shares in circulation, the profits of the company are distributed among fewer shares. Thus, Tootsie shareholders (and insider owners) enjoy a larger share of the company each year, without having to reinvest dividends to buy more shares.
Indeed, the company has reduced the number of shares outstanding by more than 1% on a yearly basis. Although this is good for shareholders since it improves per-share results, I believe that reinvesting this money back in the company itself, improving production capacity, adding new product lines in its various brands through innovation, or acquiring competing brands and companies would represent a use of cash that would benefit shareholders much more in the long run term.
The bankruptcy risk in Tootsie roll is minimal as they maintain a zero-debt balance sheet. This conservatism on the part of management carries the risk that sales could enter a downward spiral, forcing the company to leverage at an inappropriate time in order to turn things around. This possibility is derived from the risk of not adapting to changes in consumers due to risk aversion on the part of the company's management and its habit of not acquiring debt for acquisitions. On the other hand, a second round of mandatory lockdowns derived from second waves of the coronavirus would likely hurt the company's sales, as the first six months of 2020 have demonstrated. Overall, I consider Tootsie Roll to be a fairly safe investment that deserves further research from dividend growth investors since the company has ample resources to handle the different risks mentioned. It has a nice free cash flow to equity to meet its obligations, it has no debt, and so the means to leverage for acquiring a big competitor, and its high cash on hands guarantees the survivability of the company during the current coronavirus crisis (this could actually benefit Tootsie Roll in the event that some competing factories close because they go bankrupt as a consequence of the crisis).
Currently, you can't expect much from Tootsie Roll Industries. What shareholders can grab from their shares is a ~1.10% annual dividend plus a 3% stock dividend and a 1-1.5% buyback yield, since growth is totally stagnant as a consequence of the management's lack of interest in increasing sales through acquisitions. A 5% annual return is a conservative number to expect from here. I think that a 5% return does not offset the risks of acquiring shares in a company whose sales have been completely frozen for the last decade, and whose management does not show much interest in changing the course of the company in this regard.
If you feel bored with more known companies with more growth, which are in many cases consumer goods companies just like Tootsie, be prepared to be really patient while sleeping well with this one. Personally, I would not like to own a company offering a dividend yield of just a little more than 1% and a 3% annual stock dividend, whose sales are totally stagnant while the management invests cash surpluses in buying back more and more shares over the years, possibly because this increases their own participation in the company. In any case, I must admit that it is a company that has remained alongside many generations throughout history, whose business has survived all kinds of ailments. I believe the business model of the company is excellent itself, and the balance sheet is quite underleveraged, but I would like to see a management prompted to continue growing the business borders. Nevertheless, the management has admitted that they are continually looking for potential purchases in the last 2019 annual report. I believe that as soon as the company announces its intention to make a large acquisition, it would be time to revisit this company to consider acquiring shares. Meanwhile, I will stay on the sidelines.
Receiving a ~1.10% dividend yield and a 3% stock dividend, plus 1% to 1.5% annual buyback yield is a very expensive price to pay for a company whose sales and revenues have remained stagnant for more than one decade. The reason I could give Tootsie Roll a shot is the 3% stock dividend paid usually in April every year. Nevertheless, I honestly think there are infinitely better options out there to look for.
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