Updated on October 6th, 2020 by Josh Arnold
Tootsie Roll Industries (TR) has a dividend growth track record that few companies can rival. The company has increased its cash dividend for 54 consecutive years and has paid continuous quarterly dividends for even longer. That puts the company among the elite Dividend Kings, a small group of stocks that have increased their payouts for at least 50 consecutive years.
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Dividend Kings are the “best of the best”, when it comes to rewarding shareholders with cash. Tootsie Roll Industries has a long history of dividend growth, but the current yield is relatively low at 1.2%.
This article will discuss Tootsie Roll’s dividend and valuation outlook.
Business Overview
Tootsie Roll traces its roots back to 1896 when Leo Hirschfield began selling his candy from a family recipe in his shop in Brooklyn. He then went to work for The Stern & Saalberg Company, which later became The Sweets Company of America, and eventually morphed into the enterprise we know today.
The company’s history of innovation when it comes to candy products began with Hirschfield’s inventive mind creating various patents surrounding the way candies are made and indeed, the very texture of the company’s signature Tootsie Roll. That spirit of innovation was key to Tootsie Roll’s beginning and its subsequent growth, something that was helped along by two world wars.
Tootsie Roll saw tremendous growth and mainstream adoption of its candies during World War 1 and World War 2 as Tootsie Rolls were added to military rations, owed to their very tough texture that could go anywhere soldiers could.
While WW1 and WW2 were horrible events in human history, they helped make Tootsie Roll into what it is today. To its credit, the company seized the opportunity to supply its treats to the US military and that relationship continues through today.
Tootsie Roll’s market capitalization is right at $2 billion after a sharp selloff earlier this year, and the company produces around $500 million in revenue in normal years. However, with the status of the critical Halloween season in jeopardy due to COVID-19 concerns, we are cautious on Tootsie Roll’s 2020 revenue outlook.
The vast majority of sales are made in the US but it does sell in Canada and Mexico as well. Tootsie Roll sells its products through a network of 4,000 customers that include wholesalers, discount chains, dollar stores, supermarkets, the US military and others.
Tootsie Roll’s brands have grown over the years from the original Tootsie Roll to various spin-offs of that brand, as well as entirely new lines.
The company branched out into bubble gum with its 2004 acquisition of Concord Confections; it also makes lollipops of various types and some chocolate products as well. Although Tootsie Roll has moved into some different candy products, it still has a very narrow focus and while that allows it to be very good at what it does, it also means growth opportunities are limited, as evidenced by its years of stagnating growth.
Tootsie Roll certainly has its niche built out in the world of candy, but it is not without its risks. First, it is beholden to commodities prices, as any candy maker would be. Tootsie Roll obviously buys a lot of sugar and corn syrup and as a result, swings in the prices of those commodities can significantly impact the company’s profitability. It hedges these commodities at times but it cannot escape the fact that it is subject to the whims of the markets in which these and other commodities trade.
Tootsie Roll also has largely fixed operating costs at its manufacturing facilities, so when revenue declines, as it did in the second quarter of this year, profitability suffers. Revenue was off 25% in Q2 as the company saw drastically reduced demand from retail outlets as a result of COVID-19 closures. Net earnings declined by about a third, falling from 17 cents per share to 11 cents per share.
In addition, there is also the matter of Tootsie Roll’s dual class structure, and the fact that it is run essentially like a private company by the Gordon family. The family controls the vast majority of the voting rights of Tootsie Roll, so the company is under complete control, just as it would be if it were private. So long as the Gordon family is in charge, it appears Tootsie Roll is going to simply maintain status quo instead of chasing growth opportunities or a sale of the company.
Tootsie Roll possesses a long list of customers but it is particularly reliant upon Walmart (WMT), which accounts for about one-quarter of the company’s total revenue. That’s an enormous reliance upon one customer and while it means Tootsie Roll has a great relationship with Walmart that works, it also means that should Walmart decide to dedicate valuable shelf space to a different product, Tootsie Roll could lose a tremendous amount of revenue.
The company’s relationship with Walmart has grown over the years so this isn’t an imminent risk, but it is certainly something for investors to watch given that Tootsie Roll is so reliant upon this particular relationship.
Growth Prospects
Tootsie Roll Industries has had a hard time producing meaningful growth over the past decade. The company produced $550M in total revenue in 2012 and since that time, revenue has steadily fallen to $503M in the last four quarters. Tootsie Roll does not spend a material amount of money on research and development, so future growth is hard to predict.
What the company has tried to do to generate some growth is create seasonal innovations like Tootsie Roll Eggs, as well as new product extensions, like the Andes bar that can be snapped apart into pieces. Its core products don’t change much, so barring some sort of meaning acquisition, this is perhaps the only avenue of growth as evidenced by years of stagnating revenue.
As mentioned above, R&D isn’t really a meaningful expense for Tootsie Roll. The only real innovation comes from seasonal lines or product extensions, but those don’t drive transformational growth.
One catalyst for future earnings growth is a renewed focus on efficiency in the manufacturing operations, as well as sourcing initiatives that aim to lower cost of goods sold. There has been some expansion of gross margins over time, and operating expenses have come down somewhat.
Operating margins have ranged from 11% to 17% of revenue in the past decade, with last year coming in at 15%. We note that 2020 will almost certainly see lower operating margins because of reduced demand causing deleveraging of expenses. Without much top line growth and with margins weakening, investors should not expect high growth on the horizon.
Competitive Advantages & Recession Performance
Tootsie Roll’s competitive advantages include its product line and its distribution partnerships. The company has built a niche with its core Tootsie Roll line and its spin-offs like Tootsie Pops, as well as the fruit-flavored versions of the classic candy. Tootsie Rolls are unlike any other candy in the market – just as it was over a hundred years ago when it launched – and that is something that competitors cannot replicate.
Tootsie Roll does, however, make a very narrow assortment of candy, with its biggest departure from its core being the Concord acquisition. Keep in mind that was nearly two decades ago, so acquisitions are not a major part of the corporate strategy.
At the same time, the business model is fairly stable, which affords Tootsie Roll the good fortune of being fairly resistant to recessions, a key benefit when considering a dividend stock. The company’s earnings-per-share during and after the Great Recession are below:
- 2007 earnings-per-share of $0.70
- 2008 earnings-per-share of $0.54 (decrease of 23%)
- 2009 earnings-per-share of $0.75 (increase of 39%)
- 2010 earnings-per-share of $0.76 (increase of 1%)
Revenue fared very well during this period as it never dipped more than 1% from year-to-year, an astonishing accomplishment given the depths of the recession we experienced. However, margins performed erratically due to input costs, and the company’s income tax rate also moved around. That led to lumpy earnings, but on the whole, revenue was basically flat and earnings fell but fairly quickly recovered.
During the coronavirus recession, Tootsie Roll’s Q2 was weak due to closures in the economy, and its critical Halloween selling season is still very uncertain. However, we continue to see Tootsie Roll as recession-resistant under most circumstances.
Valuation & Expected Returns
We currently expect Tootsie Roll to produce 96 cents in earnings-per-share for this year, which would be flat from 2019. We believe Tootsie Roll does not have high enough growth to justify its current valuation. Therefore, TR stock looks to be overvalued right now.
Earnings-per-share have been below $1 annually for more than a decade, the product of stagnant revenue and profit margins. This type of slow-growth business is typically assigned a relatively low valuation multiple, but the stock is valued at a price-to-earnings ratio of 31.8. This is very expensive when you consider that earnings have only fluctuated over time. We have a fair value estimate of 30 times earnings given where Tootsie Roll has traded in the past.
Tootsie Roll does, at least, provide a decent level of capital returns. The dividend yields 1.2% at present but of course, it is very safe and has been raised for more than 50 years. Growth in the payout has been slow given that earnings have been flat for many years.
The other tailwind Tootsie Roll has is a 3% annual stock dividend it pays to shareholders. This is a bit of a strange way to reward shareholders these days as stock dividends are uncommon, but the company has been doing it for a long time. Essentially, the company gives each shareholder a 3% capital return in the form of stock, which can either be held or sold to create a cash dividend of sorts. Since the stock dividend is worth 3%, if an investor sells the stock dividend, the annual total yield could be viewed as north of 4%.
From a total return perspective, the valuation multiple is quite high, meaning further expansion seems unlikely. If anything, the multiple could contract as the stock looks very overvalued. As a result, we see total returns of just 2.9% annually over the next five years.
Final Thoughts
Tootsie Roll isn’t a high-yield dividend payer by any means but it does offer the quirky kicker of a 3% stock dividend each year. That’s something investors don’t get most places and it can either be used to increase one’s stake in absolute terms or it can be sold to create a larger cash payout.
However, the company has a lot of fundamental issues that make it such that the stock looks very expensive. Margins are in focus but have not improved, while sales have struggled to grow in recent years. Plus, as candy is a fairly mature industry in the U.S., it seems the stock lacks meaningful growth catalysts. As a result, future returns are likely to be low going forward. We rate the stock a hold.
