Tootsie Roll Industries (TR): A Dividend King With a Safe Payout and Iconic Brands

Dividend kings, stocks with 50+ consecutive years of dividend growth, are a rare and prized collection of generally low risk income growth investments.

 

Many of these companies have established leadership positions in the markets they serve through some combination of economies of scale, intellectual property, and customer relationships.

 

In the case of Tootsie Roll (TR), the company has increased its dividend for 51 consecutive years thanks largely to its portfolio of popular candy brands.

 

Given Warren Buffett’s affection for popular food brands in his dividend portfolio here, let’s take a closer look at Tootsie Roll to see if this dividend king could be an appealing long-term investment.

 

Business Overview

Founded in 1896 by Leo Hirschfield in Chicago, Illinois, Tootsie Roll is the maker of famous candy brands as Tootsie Roll, Tootsie Pops, Child’s Play, Caramel Apple Pops, Charms, Blow-Pop, Junior Mints, Charleston Chew, Sugar Daddy, Sugar Babies, Andes, Razzles, and Dubble Bubble.

 

 

It sells its products primarily through 30 candy and grocery brokers to over 4,000 supermarkets, variety stores, dollar stores, chain grocers, and drug chains in the US, as well as numerous outlets in Canada and Mexico, which are its largest foreign markets.

 

The company also sells in Europe, the Middle East, and Asia, but the US is its largest market, accounting for roughly 92% of total product revenue.

 

Business Analysis

Tootsie Roll’s large portfolio of well-known brands generally means that its sales are steady in all types of economic environments, which is important for a company that has become famous for clockwork-like annual dividend increases.

 

That being said, like most food companies, Tootsie Roll isn’t a fast-growing company. In fact, sales peaked in 2012 and have been gradually declining ever since.

 

 

Fortunately, management has proven effective at maximizing the company’s economies of scale and cutting costs in recent years.

 

In fact, thanks to its specialized, high-speed equipment, and highly automated manufacturing facilities, the company has been able to generate steady improvements in margins and returns on shareholder capital.

 

This is courtesy of the company launching its “enterprise resource planning” system, or ERP, in 2011. This corporate turnaround plan was based on using advanced analytics to help managers streamline and maximize the flexibility of the company’s manufacturing systems and supply chain.

 

 

In fact, today Tootsie Roll enjoys some of the industry’s highest profitability.

 

 

Going forward the company has four opportunities to stabilize and return to moderate sales growth.  The first is launching new product lines such as Cella Dips (chocolate covered whole dried cherries) and caramel marshmallow Sugar Babies.

 

The second is increased distributions of existing products, especially in emerging markets such as India and China, where a fast-growing middle class could fuel a large increase in per capita candy consumption.

 

Third, the company is revamping its advertising budget away from more traditional routes, such as TV and print, and towards a greater focus on social media, such as Twitter, Facebook, and Instagram.

 

This shift is intended to increase its brand awareness and popularity with Millennials and America’s youth market.

 

And finally, the company can continue to grow through acquisitions as it has over the past 120 years, when it purchased such well-known brands as Andes, Dubble Bubble, Junior Mints, and Dots.

 

Key Risks

While Tootsie Roll’s status as a dividend king is worthy of respect, there are nonetheless several major risks to owning this stock.

 

The most obvious is that, while the company’s ability to boost its margins over time with increasing use of automation and cost cutting is impressive, there are limits to how how high margins can go, especially given that its key ingredients (such as sugar and coco) are highly cyclical commodities.

 

Which means that at some point Tootsie Roll’s dividend growth prospects will slow unless it can turnaround its declining sales.

 

Unfortunately, the US, its largest and most important market, is largely saturated, meaning that organic sales growth potential is pretty much limited to matching 1% to 2% population growth.

 

However, that may not prove the case if shifting consumer sentiment, specifically away from high sugar snacks, results in weaker future candy sales.

 

And while foreign markets can serve as a good potential source of growth, remember that the global candy industry is massively competitive, dominated by giants such as Hershey’s (HSY), Mondelez International (MDLZ), and Nestle (NSRGY).

 

These well-capitalized rivals are potentially able to better compete in faster-growing emerging markets with advertising budgets orders of magnitude larger than Tootsie Roll’s, as well as potentially better knowledge of local tastes.

 

That means that the company’s best bet to achieve stronger top line sales growth is through acquisitions, which always come at the risk of overpaying and underperforming on execution (i.e. failing to achieve expected synergies).

 

Finally, anyone interested in Tootsie Roll should know that the company, although public since 1922, is effectively a private company, under the total control of the Gordon family, including the current chairwoman and CEO, 85-year-old Ellen Gordon.

 

 

Ms. Gordon took over control of the company from Melvin Gordon in 2015, upon the death of the 95-year-old CEO who had run the company for over 50 years.

 

Normally strong insider ownership is a good thing, as is very long management tenure, because it aligns the incentives of management with those of shareholders and means that executives have plenty of experience in achieving steady growth.

 

However, in this case, Tootsie Roll, due to its dual class share system, is entirely under the control of the Gordon family. This is because Ms. Gordon’s father, William Rubin, took over a large controlling interest in Sweets Company of America (Tootsie Roll’s precursor) in the 1930’s after the death of its founder.

 

 

Which means that today, Ellen Gordon controls 79% of the voting rights in Tootsie Roll, giving her absolute say in all corporate policies, thanks to her almost exclusive ownership of the company’s class B shares which have 10 times the voting rights of common stock. These shares were created in the 1980’s to ensure the couple’s lock on power.

 

Critics of the Gordons, including shareholders who have periodically sued management over the years, claim that the Gordon’s have abused this absolute power by paying themselves lavishly in both salary and benefits.

 

For example, in 2012 Mr. and Mrs. Gordon were paid $7.6 million in salary, made use of the company jet for private reasons (flying between their primary home in Massachusetts and Chicago) to the tune of $1.2 million, and had the company pay for their $10,500 per month Chicago apartment, where they stayed part time when working from the corporate headquarters.

 

All told, that meant that the couple’s compensation  was $8.9 million, 1.6% of the company’s total revenue that year.

 

In addition, Ms. Gordon isn’t a big fan of transparency, and as a result the company doesn’t do conference calls, issue guidance of any kind, or even have an investor relations page.

 

In other words, anyone owning shares of Tootsie Roll has to accept the fact that they are completely at the mercy of non-transparent management, who can do almost anything it wants, as well as pay itself whatever it likes (top five executives were paid $12.1 million in 2015, or 2.3% of revenue).

 

Tootsie Roll Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Tootsie Roll has a Dividend Safety Score of 99, which suggests that the company offers one of the safest and most dependable dividends on Wall Street.

 

That’s not surprising given its 51-year payout growth history.

 

In fact, Tootsie Roll has paid an uninterrupted quarterly dividend for 77 years and has also paid an annual 3% annual stock dividend for the past half century.

 

This kind of steady performance and high dividend security is due to three main factors.

 

The first being that food companies in general have very stable (if slow growing) sales, earnings, and cash flows. After all, even during recessions people need to eat, and candy is a low cost indulgence that generally isn’t highly cyclical.

 

Next, management has been very conservative with the company’s dividend growth, maintaining very low EPS and free cash flow payout ratios below 40% most years.

 

 

With the annual cash dividend consuming only about 30% of any year’s EPS and about 25% of free cash flow, the payout is extremely well insulated against any unexpected negative events, such as a sharp spike in commodity prices or currency swings which would ding earnings.

 

Finally, we can’t forget the importance of a strong balance sheet, which offers the company plenty of flexibility to both invest in future growth, as well as continue rewarding investors with the steady payout growth for which Tootsie Roll is famous.

 

As you can see, Tootsie Roll’s enjoys a pristine, fortress-like balance sheet with no debt, a substantial cash position (enough to cover nearly seven years of dividends), and one of the strongest current ratios (short-term assets/short-term liabilities) not just in the industry, but of any company on Wall Street.

 

 

In fact, when we compare Tootsie Roll’s metrics against its industry peers, things look even better.

 

 

That’s because this is a highly capital intensive industry, generally marked by a very high leverage ratio (Debt/EBITDA) and low current ratios.

 

In contrast, Tootsie Roll’s lack of debt and high current ratio mean that, if it were ever to issue bonds (such as to make a large acquisition), it would likely receive a high investment-grade rating that would allow it plentiful access to very cheap growth capital.

 

Tootsie Roll’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Tootsie Roll’s Dividend Growth Score of 75 indicates that it has above average dividend growth potential. However, that’s largely due to its low payout ratios and not necessarily because of a history of fast dividend growth.

 

 

Going forward Tootsie Roll should be capable of 1% to 2% organic sales growth, which it can boost to 2% to 3% through acquisitions.

 

Combined with ongoing margin expansion from cost cutting and larger of economies of scale, as well as steady 1% to 2% net share buybacks (2.4% annually over the past 5 years), Tootsie Roll might be able to generate long-term EPS growth of 5% to 7%.

 

And because its payout ratios are so low, Tootsie Roll could provide dividend investors with somewhat faster payout growth, should management want to, along the lines of 6% to 8% over the coming years.

 

Of course, this is merely the company’s potential earnings and dividend outlook. Whether or not Tootsie Roll manages to achieve it depends on stabilizing its declining sales, returning to top line growth, and rational decision-making from the management team. If sales continue declining, than shareholders should only expect 4% to 6% payout growth going forward.

 

Valuation

Over the past year Tootsie Roll has underperformed the S&P 500 by about 15%. However, that doesn’t mean its valuation is attractive. In fact, the stock’s valuation appears quite rich.

 

For example, TR’s forward P/E ratio is 36.5, more than double the S&P 500’s 17.8. It’s also much higher than its industry peers, who have a median forward P/E ratio of 20.2.

 

And while Tootsie Roll has never been especially cheap (over the past 13 years its median forward P/E ratio was 30.5), today’s valuation looks especially stretched.

 

In other words, while Tootsie Roll’s industry leading profitability and impressive dividend growth record mean it probably deserves a market premium, today’s share price represents an 81% premium to its rivals, which is probably not warranted given its slow growth potential.

 

Meanwhile, the current cash yield of 1%, while in line with its historic 1% yield over the past 22 years, is only about half that of the broader S&P 500, which yields 1.9%.

 

In addition, it’s far below the industry median yield of 1.9%. In other words, Tootsie Roll’s low payout doesn’t offer investors much, especially considering that the company isn’t exactly experiencing fast earnings growth.

 

Now in fairness, the company’s annual 3% stock dividend does mean that investors can probably achieve long-term total returns of 9% to 11% (4% total yield + 5% to 7% potential earnings growth) with 9% to 10% being the more likely conservative estimate.

 

While that may be decent total return potential, especially for a dividend king, the fact remains that TR’s forward P/E ratio carries significant risk, especially when combined with some of the company’s questionable management practices.

 

Conclusion

While there is a lot to like about Tootsie Roll, at the same time the company has major issues it needs to deal with, most notably its weakening top line and potential succession issues when Ms. Gordon becomes unable to fulfill her duties.

 

When combined with a very low cash yield (unlike some of the best high dividend stocks here), modest payout growth prospects that make it a weaker income growth stock, and a potentially frightening valuation, I simply can’t recommend Tootsie Roll for any diversified dividend portfolio.

 

That’s especially true when there are far better dividend aristocrat alternatives, which offer more yield, stronger long-term dividend growth potential, and more appealing valuations.