Description

Tootsie Roll Industries (TR) sells a variety of candy brands, but the majority of its sales still come from the sale of Tootsie Rolls.  

The FAQ page of the company’s website says they produce 64 million Tootsie Rolls each day.  It said the same thing in 2014 as well.  This is not a growth business, and I think over time unit volumes will decline.  It’s not a product that fits with health trends; Tootsie Rolls are substantially worse for your teeth than other chocolate candys and don't have any redeeming qualities.  My personal experience, there’s no reason to give your kids a Tootsie Roll when they will like Hershey’s or M&M’s just as much and the chocolate doesn’t get stuck in the crevices of their teeth.  Maybe that’s just my experience, but my kids seem to get through life okay just eating M&Ms on Halloween and throwing out the Tootsie Rolls (I just tell them they are allergic).

The thesis isn’t that the world will suddenly stop eating Tootsie Rolls, it’s just that the world isn’t going to suddenly start eating them in greater quantities either which I think is all you need to believe for TR be dead money from here for many years (at best) at ~41x EV/NOPAT (generously giving $1 of value to every $1 of cash that might sit on the balance sheet forever). 

In the ZIRP days, when this used to trade closer to 30x earnings it looked expensive, but at least made some sense as a bond-like alternative.  Tootsie Roll volumes aren’t growing, but they’re not declining either.  A stable 3.5% earnings yield that probably has some inflation protection was arguably better than a 2% 10yr treasury for some investors.  But when treasuries spiked, so did TR!   Now, who wants a 2.4% earnings yield (managed by bad capital allocators) that’s unlikely to grow when a 3.6% 10yr treasury is an option.  It makes no sense (to me at least).  The stock rose 34% since October.  My best speculation is that this was a heavily shorted stock, with long tech & short no-growth / dying businesses a generally popular strategy among the hedge fund community.  With the tech sell-off, maybe there has been forced buying of TR as hedge funds de-grossed.  That’s the best explanation I can come up with for a bond-proxy trading up 34% when rates skyrocketed.  It’s also possible that the surge in operating earnings (which is due to an accounting quirk, does not reflect economic reality, and is more fully described below) is misunderstood, but that seems unlikely.

Whatever the reason, I don’t see much upside to this at 41x earnings in this rate environment.  I don’t see any reasonably likely catalyst and even if this is just dead money, parking the proceeds in T-bills yielding 4.8% while paying 1% in dividends and borrow cost seems like a decent return while you wait for the October to January rally in TR to most likely mean-revert.

Financials:

TR has a weird hedging strategy whereby they have trading securities that offset some form of deferred compensation.  So, for example, in the 1^st 9 months of 2021, they had Earnings from Ops of $47M (but gains on trading securities of $8.6M); but in the 1^st 9 months of 2022, they had Earnings from Ops of $83.4M (but losses on trading securities of $20.8M).  Their Ops weren’t suddenly 77% more profitable YoY.  The “economic earnings” of the business are really Earnings from Ops + Trading Security Gains or Losses which are included below the line in Other Income.  So, to get an estimate of 2022 earnings, I just take the % increase in that metric of economic earnings in the first 9 months of 2022 over 2021 and apply that % increase to the same metric for the full year 2021, then tax it to get a 2022 NOPAT estimate of $69.7M.  To get the EV ($2.85B), I deduct cash/securities (excluding the trading securities that just hedge real compensation expenses) from the market cap. 

Risks:

1. Potential meme stock.  It was a brief (and not too crazy) participant in the meme rally of 2021.  It’s a small position for me for this reason.
2. The Gordon family controls the company through super voting shares.  If Ellen Gordon (90 years old) dies and her kids want out, this could be an acquisition target. I’m comfortable with this risk as I don’t think anyone would want to buy this company at a premium to 41x earnings.  I also don’t think the Gordon children (now in their 60s) would want to sell against their mom and dad’s wishes (see below article excerpt from 2005) and economically I don’t think it makes sense for them to do so since they can overcompensate themselves for no work given their controlling stake.  Ellen Gordon makes ~$5M/year as CEO.  That’s 7% of NOPAT.  They own around 38% of the shares.  So, they’d need an 18% premium to “break-even” with the lost compensation they can pay themselves.  2005 Article: Usually they don't respond to rumors, but Melvin and Ellen Gordon, the publicity-shy husband-and-wife team that's run the Chicago candymaker since the 1960s, made it clear after the company's annual meeting last week that they intend to keep Tootsie in the family for another generation. "Oh yes, very much so," said Mrs. Gordon, 73, when asked if the succession plan is to pass the firm down to their four daughters. All four are trustees of a trust that is the beneficiary of split-dollar life insurance policies the company has taken out on their parents, according to filings with the U.S. Securities and Exchange Commission. Such an arrangement could help offset any capital gains taxes that might otherwise force a sale down the road. "We have four professional daughters who all have their own businesses, but they're very involved in the company in a number of ways," said Mrs. Gordon, president and chief operating officer. "None of them are working for the company, (but) they're very much involved in some of these strategies and discussions and they're certainly up on everything." "As far as personnel, I don't know whether our daughters would enter the business or not. That's up to them," said Mr. Gordon, 85, who succeeded his father-in-law as chairman and CEO in 1962. At which point, Mrs. Gordon interjected: "They're all interested."

Catalyst

Time