A 'Private' Company in Public Company Garb and Not Just for Halloween?

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Tootsie Roll (NYSE: TR) and Tootsie, the 80's flick starring Dustin Hoffman, have more in common than just the name. The movie -- which is a hoot -- begins with Hoffman's character, an actor in the film, disguising himself as a woman so he can win a female role. The fun follows.

Tootsie Roll also seems to be in drag -- in its case, as a public company. Movie viewers may find Tootsie's drag humorous, but investors should find Tootsie Roll's drag no laughing matter.

A Slice of Old Americana

Tootsie Roll is a feel-good company. It's an old (founded in 1896) American (founded in NYC, now based in Chicago) candy company that many associate with childhood. While its products didn't quite do it for me like Hershey's (NYSE: HSY) Reese's Peanut Butter Cups, I did go through a big Charleston Chew phase. Junior Mints, Dots and Sugar Babies were welcome Halloween treats. And, like most kids, I was a sucker -- pun intended -- for an occasional Tootsie Pop or Charms Blow Pop.

In addition to the iconic Tootsie Roll, some of the company's other products include Andes Mints, Child's Play, Dubble Bubble, and Sugar Daddy. 

Though the company itself has that feel-good factor, its stock does not. While Tootsie Roll may prove to be a decent investment going forward for one reason, there are traits about it that are illustrative of the type of stock investors should generally roll clear of. 

Tootsie Roll's Drag is a Drag for Investors

This company is a publicly-traded company that doesn't act like one. Shareholders of publicly-traded companies have the right to a certain degree of transparency, among other things. And they evidently haven't been getting it at Tootsie Roll.

The candy industry in general is very secretive, so some degree of secrecy is to be expected. However, the company's secrecy is to the point that it is the reason why stock analysts don't follow this company. Apparently, it's an exercise in futility. The Wall Street Journal's Tootsie's Secret Empire nicely outlined this topic. 

How Does a Public Company Get Away with this Behavior?

My take is these three primary reasons:

  • Almost 50% insider-ownership -- Insider-ownership is a great thing. Companies with higher than average insider-ownership usually make for better stock investments. However, sometimes insiders can have too much power.                                
  • Good VERY long-term performance -- The current management -- a 92-year-old CEO and his 80-year-old COO wife (we'll get to this) --delivered good returns about 15+ years back. Hence, there was no reason for investors who have owned the stock for several decades to squawk. However, the stock's performance has been poor for over a decade, as competitors -- namely Hershey -- have experienced decent to good gains. 
  • Emotional Factors -- Some investors could have a sentimental soft spot for the company's products, which clouds their judgments about the stock.

How Can Investors Uncover (no pun intended) Such In-Drag Situations?

Check Corporate Governance ratings. They are not the end all, but, in a glance, you will know if you need to dig further. 

Tootsie Roll's ratings:

<table> <tbody> <tr><th><span>Corporate Governance</span></th><th> </th></tr> </tbody> </table>
<table> <tbody> <tr> <td>Tootsie Roll Industries Inc.<span><span>’s</span></span> Governance Risk Indicator (<span><span>GRI®</span></span>) as of Oct 1, 2012 is: Audit (Low Concern), Board (Medium Concern), <strong>**Compensation (High Concern),**</strong> Shareholder Rights (Medium Concern).</td> </tr> <tr> <td>Brought to you by <a href="http://issgovernance.com/grid-info">Institutional Shareholder Services (<span><span>ISS</span></span>)</a></td> </tr> </tbody> </table>

Source: Yahoo! Finance 

Compensation: High Concern ('Sugar Daddy' to Selves?)

This rating means that top exec salaries are deemed excessive and/or incentive pay structures are not aligned in the best interests of all shareholders.

This rating is particularly troublesome given the stock's performance, as per the chart below.

<img src="http://media.ycharts.com/charts/456c834527e7782fc1e7bfd5d71db456.png" />

TR data by YCharts

Note: "Max Length" refers to charting capabilities, not how long companies have been public companies. 

Sugar Daddies-to-Sugar Babies Dividends

Tootsie Roll used to be a dividend king. However, its yield has sharply dropped over the last few years and is currently 1.2%.

Hershey's dividend yield is 2.4%, which is better than it might appear because the stock price has appreciated so much over the past few years. In fact, Hershey upped its dividend rate this year. 

Mondelez International (NASDAQ: MDLZ) -- owner of Cadbury, the #1 confectionery/chocolate brand -- is yielding a tasty 4.6%. (Mondelez, which started trading in early October, was formerly part of Kraft Food, before Kraft spun-off its business, now called Kraft Foods Group.) 

<img src="http://media.ycharts.com/charts/1b70005638db27634897ecc090b61cba.png" />

TR Dividend Yield data by YCharts

Drags on Stock Price 

What's Tootsie Roll's problem? Two things -- slow revenue growth and contracting margins.

1. Revenue Growth

The revenue growth has not been adequate to offset the contracting margins. Here's the 10 year revenue picture, with Hershey shown as a comparison...

<img src="http://media.ycharts.com/charts/a1196fc5bf46030ecbb10cdd615c8bb8.png" />

TR Revenue TTM data by YCharts

The 5-year picture shows an even greater divergence between the two company's revenue growth performances...

<img src="http://media.ycharts.com/charts/e03641928ec7115337ecc4785c7d831d.png" />

TR Revenue TTM data by YCharts

2. Profit Margins

Margins have been on a downward path over the past 10 years. Hershey's profit margin has historically been lower than TR's, but that changed starting around 2011. Since then, Hershey's quarterly margins have been higher than TR's (except for the most recent quarter).

<img src="http://media.ycharts.com/charts/3aefe7ce8b7b96bdb156de61ac3cc5fa.png" />

TR Profit Margin Quarterly data by YCharts

Given the above two factors, it's no surprise net income has decreased 25% over the period. (I did check cash flows -- they look OK.) The stock price (down 8.9%) has not decreased in-line with net income because investors have bid up the P/E valuation. It's now a whopping 31! By contrast, Hershey's is about 25, and it has had considerably better earnings growth.

It seems investors have long been thinking that the Gordons, the husband CEO-wife COO team, are going to hand the reigns off to others or sell the company. Given the Gordons are now aged 92 and 80, it's understandable this "they'll be retiring soon" thinking has been going on for awhile. The stock valuation appears to have been bid up with the thought that shareholder value will be unleashed once new top management is in place or the company is acquired.

There are reasons to believe shareholder value will be increased. These include:

  • Potential aggressive international growth -- The company is not aggressively expanding internationally, as are competitors. 
  • Strong Balance Sheet -- 0 debt vs. Hershey's 2.0 Debt/Equity ratio
  • Relatively Low Price/Book Valuation -- 2.4 vs. Hershey's 15.8

Shareholders would likely see a decent return if the company is acquired. Surely, there is value in a brand like Tootsie Roll (One has to wonder if Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) would be interested? Buffett likes strong consumer brands, especially those producing sweets, with solid balance sheets.) However, the same can not be said if new management takes over. Given that existing management has apparently not made its succession plans transparent, there are big question marks. How can shareholders be sure more of the same (stagnant stock performance with generous top exec compensation) does not go on, but under a new regime?

Bottom Line

Long-term investors should generally pass on the stock. The public company "in drag" issues -- such as the lack of a communication of a succession plan and "High Concern" rating for compensation -- are concerns. Additionally, the stock price is richly valued based on P/E and PEG measures, with good news already at least somewhat built-in. Long-term investors wanting to invest in the confectionery industry --and chocolate is a market with strong tailwinds, in my opinion -- have other options.   

However, speculators willing to bet on a sooner-rather-than-later take-over might find Tootsie Roll's risk/reward trade-off a decent bet. 


BAMcKenna has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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