This recent article on the Tootsie Roll company over at The Conservative Income Investor had me mulling over the confectionery industry. Let’s take a look at 3 of the major confectionery businesses: Hershey, Mondelēz, and Tootsie Roll. We’ll gather 4 years worth of data off Google Finance (2011-2014) and analyze some of the basic financial ratios associated with each. Then, we’ll see which one of the three is the most attractive investment opportunity based on this data set.
Delicious Sugary Treats
First, let’s talk about all the delectable products each of these companies make.
The Hershey Company creates: Reese’s Peanut Butter Cups, Hershey’s Chocolate Bars, Twizzlers, Almond Joy, Kisses, Jolly Rancher, York Peppermint Pattie, to name just a few.
Mondelēz International makes: Cadbury, Oreo, Ritz, Chips Ahoy, Stride, Trident, to name just a few.
And finally, Tootsie Roll Industries concocts: the legendary Tootsie Roll (which I absolutely hated getting as a child at Halloween), Caramel Apple Pops, Double Bubble, DOTS, Razzle, to name just a few.
You know what all three of these companies have in common besides making delicious sugary treats? They make hand over fist in profits from selling these delicious sugary treats.
So let’s take a look at some figures from the Income Statement:
What’s something you notice? Look at that net income generation to tangible assets that Hershey’s commands. Hershey is able to generate almost double the net income – and fairly consistently to boot – of either Mondelez or Tootsie Roll off their tangible assets (total assets minus intangible assets). Using tangible assets gives you a rough idea of what each business can generate in pure profit entirely from the factory, plant, and equipment.
Let us now peruse the Balance Sheet:
Ratios such as the Return on Assets, Return on Equity, Return on Invested Capital, and Return on Capital Employed all provide clues as to how strong and profitable the economic engine of a business is. A general rule of thumb is that you want these figures to be consistent and higher than the industry average.
Using the Dupont Model for Return on Equity, we can break down the 3 main components that go into ROE and take a closer look at what’s driving ROE. The equity multiplier refers to the amount of leverage that each company utilizes, and it’s clear that Hershey’s uses the most debt. If we strip away the leverage, we can see what the true ROE figure is if no debt were employed. Take a wild guess which company has the strongest non-leveraged ROE figure.
Finally, let’s glimpse at the Cash Flow Statement:
Tootsie Roll has the lowest capital expenditure as a percentage of operating cash flow of all three. Checking back on the balance sheet, Tootsie Roll also has the lowest debt margin of the three. Tootsie Roll Industries is the most conservative company of this lot. However, that isn’t necessarily a good thing. If you haven’t already, go read that article from the beginning of this post on total returns experienced by Tootsie Roll investors over time.
While Hershey’s and Mondelez are returning close to 100% of free cash flow to owners (dividends + buybacks), Tootsie Roll is far more conservative at around ~50% of free cash flow to owners.
Jumping back up to the Income Statement, we can see Tootsie Roll spends nothing on Research and Development. Along with minimal advertising, that’s probably not a great recipe for revenue and profit growth. Don’t get me wrong, they are very profitable, just not as profitable as Hershey’s.
Effects on Total Return
Here’s the difference in total returns experienced by a Tootsie Roll Industries owner and The Hershey Company owner over 15 years based on an initial $10,000 investment (dividends reinvested).
Tootsie Roll Industries
The Hershey Company
Yikes. The owner of Hershey’s trounced the owner of Tootsie Roll by 7.6% CAGR. That’s a huge difference. Owning Hershey’s instead of Tootsie Roll would have generated close to $36,000 more in total wealth.
Analyzing the three financial statements prior to an initial investment and comparing amongst its industry peers might have provided clues on which economic engine had the highest probability of generating the best risk-adjusted return.
(I didn’t include a similar comparison with Mondelez as it was only created in 2012 after Kraft spun off into two separate companies and I am unsure how to adjust for that going back to 2000).
When you start peering into those boring financial statements and looking at profitability ratios, it’s fascinating what you will find. I’m sure if I included those 3 statements without naming which company a particular statement belonged to, you would be able to make a pretty good guess as to which was the most attractive investment opportunity.
Of course, calculating and looking at financial ratios are only one part of the total process of evaluating a potential business you may want to acquire. But don’t forget this step in your analysis – you’ll discover some interesting figures.
*If you want to verify the ratios, you can grab the raw numbers from either Google Finance or Morningstar.