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Candy Is Dandy--but Not Tootsie Roll


This summer's sharp rise in shares of Hershey Foods gave investors the kind of potential takeover action that's all too scarce on Wall Street these days. So please forgive those who might be craving a similar sugar rush. Just don't follow anyone who sees one sometime soon at Tootsie Roll Industries (TR).

Believe me--or, better yet, check with my dentist--I've got nothing against Tootsie Rolls, Tootsie Pops, or any of the other treats this venerable Chicago company has added to its lineup, including Junior Mints, Sugar Babies, Dots, Charleston Chew, and, most recently, Andes Mints. But after looking at its recent record and considering the company's ownership, I figure that Tootsie Roll may be worth endangering a few fillings--just not my stock portfolio.

It's important to note right off that Tootsie Roll is in no imminent peril. In fact, it shows many hallmarks of an excellent investment. Most notable are its fat operating-profit margins (23% in the past four quarters), bountiful cash flow ($47 million, after capital spending and dividends, on sales of $424 million), and a balance sheet that is sweetness itself. With $71 million in cash plus $150 million in municipal bonds, Tootsie Roll at last report had liquid assets enough to pay off all liabilities and still keep $99 million. Its main assets, the candy brands, "are strong and getting stronger," President Ellen Gordon told me.

So what's the problem? First, growth, or the recent lack of it (table). Yes, sales so far this year have gone up, but by less than 0.2%. Tootsie Roll's most recent financial report attributed that showing to "effective marketing programs," leading one to wonder what would happen to sales under ineffective marketing programs. Worse, earnings before interest, taxes, depreciation, and amortization, or EBITDA, sank nearly 9% in the year's first half. Much larger rivals Hershey and William Wrigley Jr. saw EBITDA climb more than 6% and 13%, respectively, in the same stretch.

Even as Tootsie Roll finishes the September quarter--by far its biggest each year, as retailers stock up for Halloween--it can look forward to an easier quarterly comparison. Last year, third-quarter sales fell 4%, and EBITDA sank more than 9%. "Declining consumer confidence and [a] slowdown in consumer spending in the retail sector contributed to the softness," the company reported. Given the chill that the terrorist attacks put on last year's Halloween, this explanation makes perfect sense. Except that Hershey and Wrigley shook off the blow: Both recorded smart gains in sales and earnings.

This gap between Tootsie Roll and other companies selling in the same supermarket aisles, together with its description of the current year's sluggish sales, raises a question about management accountability. Management's reports to shareholders are studies in minimalism, and when I spoke with her, Gordon betrayed no worry about poky growth. Tootsie Roll only wants sales that turn a nice profit, not sales for the sake of growth, she said, adding that its strong balance sheet will enable it to make acquisitions when a promising target turns up.

Gordon, who is 70, and her 82-year-old husband, Chief Executive Melvin Gordon, control Tootsie Roll via a majority stake in its Class B shares, which get 10 votes to the common stock's one. The company's succession plan envisions a role for some or all of their four daughters, as well as Tootsie Roll's nonfamily managers. Yet neither of the elder Gordons plans on retiring soon. What if Wrigley, whose premium bid nearly captured Hershey, were to come calling with a takeover offer? "We believe that remaining independent is best for our shareholders," Gordon told me.

One day, naturally, that may change. Wrigley offered to buy Hershey at 20 times its past four quarters' EBITDA. At that, Tootsie Roll, now near $31 a share, would go for some $40. Today, the market values Tootsie Roll at 16 times EBITDA. That's squarely between Hershey's multiple of 15 and Wrigley's 17, even after adjusting for the companies' varying levels of debt. Hershey and Wrigley are not only far bigger but also growing faster. From Tootsie Roll, toothsome morsel that it may be, expect no sugar rush. By Robert Barker


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