Report Entitled "More Tricks Than Treats"
Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving Tootsie Roll Industries Inc. (NYSE: TR or "Tootsie"), a producer and marketer of candies such as the Tootsie Roll, Blow Pops, and Junior Mints. Tootsie is a notoriously secretive company, has no analyst coverage, investor calls, or investor communication program. For years, investors have ascribed the highest valuation multiple in the food and candy sector to Tootsie on the “hope” that one day it will become an acquisition target.
Spruce Point has conducted an extensive fundamental and forensic accounting review of Tootsie, and believe that investors are overlooking significant problems that dampen its attractiveness as a takeover target. Our research suggests that Tootsie’s products are losing market share, its gross margins and cash flow are overstated, its main production facility has undisclosed asbestos issues, and its governance and share structure severely disadvantage common shareholders
As a result, we have a "Strong Sell" opinion and a long-term price target of approximately $18.50 - $27.75 per share, or approximately 25% to 50% downside risk.
Our detailed research report is available on our website. We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates and to tune-in to CNBC’s “The Closing Bell” for an exclusive live interview of Spruce Point’s founder Ben Axler. Please review our disclaimer at the bottom of this email.
Declining Brands With New Labeling Highlighting Consumption Challenges, Understates Health Impact:
Tootsie dates back to the early 1900s and its brands are withering along with its core customers. Sales haven’t grown in 6yrs and we estimate it is losing market share in North America. Our channel checks at key distributors such as Wal-Mart (WMT: its biggest customer), Target (TGT), CVS, Rite Aid (RAD) reveal it uniformly receives the worst product placement on the shelves (esp. during key Halloween selling season). Tootsie’s products fail to address consumer demand for healthier products, and it has resisted industry self-regulatory movements to limit marketing to children. Early adoption of new FDA labelling requirements show Tootsie has shrunk its serving size, an implicit acknowledgement consumers are eating less candy. Enhanced sugar disclosure requirements now show significant added sugar content to its products. Families and kids take notice: we estimate a box of Junior Mints, a popular Tootsie product, contains 185% of daily added sugar needs
Opaque Financial Disclosures, Overstated Gross Margins And Cookie Jar Accounting Inflating Operating Cash Flow
Tootsie is notoriously secretive about its financials: it doesn’t hold investor conference calls, invite analyst coverage, and has a minimalistic IR website. Its SEC filings omit significant information material to investors’ understanding of its business including: 1) product mix and pricing trends, 2) commodity cost impact to margins, 3) R&D expenditures. Tootsie also inflates its gross margins in a material way by excluding shipping, warehousing, and freight costs. This leads to an 800bps gross margin overstatement. Compare Tootsie’s adjusted gross margin of 31% with peers Hershey and Mondelez at 46% and 39%, respectively, and it’s easy to see that Tootsie is running an inferior candy operation. Even worse, we believe Tootsie has inflated operating cash flow by ~$50m since 2012 though early termination of its split dollar life insurance policy. In essence, Tootsie lent money to these policies for the benefit of its executives, and is now tapping the cookie jar to reclaim funds and boost cash flow
Undisclosed Asbestos And Worker Safety Issues Revealed Through Freedom of Info Requests
Bulls think Tootsie may own valuable real estate in South Chicago at its 2m sqft HQ and manufacturing facility. Our property tax record search suggests total asset value of $40-$50m for key domestic properties. Tootsie doesn’t offer plant tours and is quiet on environmental issues in its SEC disclosures. We think we know why. We completed a Freedom of Information request with Chicago’s EPA region and were shocked to learn that Tootsie has been filing annual forms related to asbestos removal. Asbestos is a known cancer-causing agent that is transmitted through the air. We hope Tootsie has protections to prevent the asbestos from entering the food supply and is adequately protecting its workers. Worker safety is an area that Tootsie appears deficient. We filed Freedom of Information requests with the Illinois and Boston OSHA/DOL districts and were dismayed to learn that Tootsie was cited repeatedly over multiple years by OSHA for “Serious” violations related to machine operations and worker safety. Tootsie’s apparent disregard for safety recently lead to a worker at its Cambridge Brands subsidiary having a finger amputated
Unjust Management Enrichment and Horrible Governance:
In our opinion, Tootsie is run for the benefit of insiders, while taking advantage of common shareholders through lavish compensation and excessive perks. Its dual class share structure allows Class B shares controlled by insiders to limit common stock voting control, while the Board is stacked with the CEO’s allies, none of which have experience in the food industry. Insiders have rigged the bonus structure in a way that virtually guarantees the maximum bonus every year, while allowing the top 6 executives to extract ~19% of adjusted SG&A in annual compensation (and grow comp more than 3x the rate of sales). Tootsie offers none of its employees equity or stock options, which virtually guarantees that no one will care about maximizing the share price
Terrible Capital Allocation Policies:
Tootsie’s balance sheet is bloated with excess cash, which has delivered declining returns on investment. Is it hoarding cash for a rainy day to cope with a large future liability? It pays a meager 1% cash dividend, and teases a 3% annual stock dividend. However, its informal share repurchase strategy appears to be a ruse to buy back common stock, thereby allowing Class B insiders to gain increasing control every year. Tootsie could direct its excess capital toward improving its operations through greater capex; yet it spends 2%-3% of sales less on capex than peers, which should be evident from both the worker safety issues and its industry lagging gross margins we noted earlier. Its past attempts at acquisitions also seemed to have failed, especially in international markets where candy is growing fastest. For example, it recently disclosed in its 10-K “Risk of further losses in Spain” and that it is seeking ways to restructure operations
Excessive Optimism of a Takeover Leading To Irrational Valuation And 25% - 50% Downside Risk:
The perennial bull case is that Tootsie insiders will sell, yet no steps have ever been taken in that direction, even with Melvin Gordon dying in 2015 at the age of 95 and his wife (now CEO) Ellen Gordon now 85 yrs old. We believe there are many “hidden” costs a potential acquirer would need to absorb (unfunded pension obligations, significant manufacturing, technology and distribution capex, change of control premiums, and other deal expenses) that could amount to an extra $165m - $235m on top of Tootsie’s already rich valuation at 4x, 19x, and 38x 2018E Sales/EBITDA/EPS. Marquee candy and snack companies such as Wrigley and Russell Stovers sold for ~3.4x sales and 17x EBITDA, while trading comps [Hershey (HSY) / Mondelez (MDLZ) / Hostess (TWNK)] in the sector suggest a valuation of 3x, 15x, and 22x 2018E Sales/EBITDA/EPS. Tootsie has declining sales, suboptimal margins, limited international presence, and its products are out of touch with health focused trends. Its shares should trade at a discount to peers. If Tootsie were to trade at 2x-3x sales, 12x-14x EBITDA or 18x-22x EPS, we could easily see 25% to 50% downside risk
About Spruce Point Capital Management
Spruce Point Capital Management, LLC is a New York based investment manager founded in 2009. The firm focuses on short-selling and special situations opportunities. The firm conducts in depth forensic fundamental research and takes an activist approach to investing. Our research challenges conventional thinking with deep fundamental analysis, analytical rigor, and conclusions rooted with our unique viewpoints. For more information visit our website, and follow us on Twitter @Sprucepointcap
This research expresses our investment opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in our complete research presentation report on our website. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained herein may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. Any historical performance achieved from any idea or opinion from Spruce Point Capital Management should not be considered an indicator of future performance. You should do your own research and due diligence before making any investment decision with respect to any of the securities covered herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities
You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and call options of the stock) covered herein, including without limitation Tootsie Roll Industries Inc ("TR" or “Tootsie” or "the Company"), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation.
This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.
To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of Tootsie or other insiders of Tootsie that has not been publicly disclosed by Tootsie. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All rights reserved. This document may not be reproduced or disseminated in whole or in part without the prior written consent of Spruce Point Capital Management LLC.
Disclosure: I am/we are short TR.