Tootsie Roll Valuation Report 2014

8/10/2019 Tootsie Roll Valuation Report 2014

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TOOTSIE ROLLINDUSTRIES, INC.

Joanna Orlova

FE449-Professor Shaked

December 1ST, 2014 9:30-11 AM


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Company Introduction

Tootsie Roll Industries, Inc. is engaged in the manufacture and sale of confectionery

products. Although its best-known products have been the classic Tootsie Rolls and

Tootsie Pops, Tootsie Rollsproducts are marketed in a variety of packages designed to be

suitable for display and sale in different types of retail outlets. They are distributed

through approximately 30 candy and grocery brokers and by the Company itself to

approximately 4,000 customers throughout the United States.

This past year Tootsie Roll has performed rather directly with the S&P500, reflecting a

beta of approximately .91 when running a regression on the excess returns of stock

performance and the S&P 500. This past year has been pretty consistent so far, with Q3

revenues and earnings being significantly higher than the rest of the quarters. When

comparing the 2014 Q3 net income which indicates about $26.67 million to that of 2013s

$26.04 million, its apparent that there is growth. However, as the revenue for 2014 Q3 is

actually lower at $192.01 million compared to the $192.71 million in 2013 Q3, its

necessary to ensure that Tootsie Roll is generating sales rather than just being very

efficient in cutting costs.

Executive Summary

In the following report, there are three different types of valuations conducted. The

valuation methodologies used are a discounted cash flow which uses the perpetuity

growth method, a comparable company analysis, which implies the share price using the

EV/EBIT and P/E multiples, and the Company Mergers & Acquisition methodology which

uses the EV/EBIT, EV/EVBITD, and EV/Sales multiples to determine share price.

Based on the results, the recommendation is to HOLD the stock as it currently is estimated

that Tootsie Rolls performance could go either way the upcoming months. This is shown

in terms of how Tootsie Roll is generally performing with the market and comparable

companies, how its currently diving into growth opportunities, and speculation on

whether Tootsie Roll is going to tackle the idea of expanding internationally and acting on

investment drivers.

Recommendation

Currenct Price One-Year Target Recommendation Downside$28.95 $28.17 HOLD -2.68%

Market Information

Shares Outstanding (mm) Market Capitalization (mm) 52 Week range FY Ends

60.52 $1,752.05 $26.03-$33.72 December 31st, 2014Valuation Ranges

Discounted Cash Flow Comparable Companies Comp M&A

$33.37-$40.07 $20.74-$28.84 $13.59-$25.34

HIGHLIGHTS


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Confectioners Industry Overview

The Candy and Chocolate Production Industry, also known as the Confectionary industry,

is in the mature phase of the of its life cycle stage. Revenues in this phase grow at the same

pace as the economy and the key market players have market acceptance of product and

brand. As well, this phase indicates a growing concentration of the industry, which holdstrue to the confectionary industry as 76.8% of the industry revenue is expected to be

accounted to the top four players, Mondelez International with 7% industry revenues,

Ferrara Candy Company 13.2%,

the Hershey Company at 21.4%,

and Mars Inc. expected to hold

35.2% of revenues.

Industry revenue in total is

anticipated to grow at an annualaverage rate of 3% to $9.1 billion

in the five years to 2019, and this

will include growth at 4.4% in

2015.

Key Economic Drivers

Commodity PricesWhile there are many common ingredients in various candy delicacies, sugar is the key

ingredient. After two years of relief from high prices of sugar that were experienced from

2009 to 2012, it is expected once again that the price of sugar is to slightly increase.

However, because of the inelastic demand for candy, candy producers are able to pass on

cost increases without hurting demand too much. In any case, Tootsie Roll, as well as a

select few competitors, has ensured that they are prepared for instances of high costs on

their own end. As a result, one of Tootsie Rolls values is to invest in manufacturing

equipment to reduce these costs brought in by commodity price increases. A veryinteresting addition is that Tootsie Roll, on behalf of its wholly owned subsidiary Sweets

Mix, has a sugar tariff exemption that could potentially be valued at close to half a billion

dollars.

INDUSTRY ANALYSIS


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Trade-weighted Index

This index indicates the value of the dollar compared with other currencies, and this is

important in regards to import and export levels. As the trade-weighted index is expected

to slightly increase over 2014, this could lead to fewer exports because its become more

expensive for foreign countries. On the contrary, a declining trade-weighted index reflectsa dollar that is faling in relative value, making US goods cheaper for international markets.

Tootsie Roll is hedging this risk through Foreign Currency Forward Contracts.

Population and demographic shifts

Children under fourteen are the leading consumers of candy, and in effect the adults that

live in households with children under fourteen are also more likely to eat candy and

chocolate products themselves. However, the number of US households with children

under fourteen is expected to decline in the five years to 2019, meanwhile households

with no children under 18 grew from $37.3 million in 2000 to 43.6 million in 2010, withthe number expected to keep increasing. This would mean marketing products more

specifically to adults, which would necessitate including the trend of a healthier lifestyle

and diversifying more into sugar-free products like granola snacks and candy with a wide

array of flavors. In order to mitigate the risk of this trend being a potential threat to the

industry, its important to adjust.

Tootsie Roll is making progress in appealing to a more adult population by introducing

smaller portions and acquiring a multitude of different companies that would allow for a

wide variety for the consumer. As well, Tootsie Roll is appealing to those with allergies

and food restrictions by having peanut-free and kosher approved products.

Per capita disposable income

It seems people would be less likely to allocate funds towards discretionary goods such as

candy and chocolate in the event that their disposable income goes down. However,

consumers actually indulge in confectioners in economic downfalls. In a good scenario

where per capita disposable income is expected to increase, consumers are still likely tobuy candy and chocolate. Quite fortunately, this good scenario is projected for this

upcoming year.

INDUSTRY ANALYSIS


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The first steps in conducting a discounted cash flow valuation are to gather relevant

industry trends and company information. I researched through various mediums like

IBIS World, the National Confectionary Association, the Tootsie Roll Industries, Inc 10-k,

annual reports, quarterly reports, and others. This research allows for a strong

understanding of how the company fits into industry trends and why it maintains certain

business strategies. Through applying research and common forecasting assumptions, Iprojected a key cash flow statement for which I used income statement, cash flow, and

balance sheet (net working capital) assumptions. The assumptions are found below:

Sales (as % growth)-As reported earlier, IBIS World stated that the projected sales

growth for this 2014 year is 3%, and that it will continue to increase to about 4.5% by the

upcoming 2015 year. Also The NCA reports that retail sales of chocolate products will

continue to increase from 3 to 4 percent per year, and so I assumed a 3.5% growth rate forthe projected time period of 2015-2019 as an estimated average.

COGS (as % sales)- is projected to decrease by the incremental amount of 2% a year

because from reading the annual reports, it was a core mission for Tootsie Roll to decrease

its costs of goods sold. The past decrease in COGS was due to certain deferred

compensation expenses in 2013 and 2012, which results from changes in the market value

of investments and investment income from trading securities. This is not reflective of

current years, but nevertheless the product cost of goods sold decreased about 4.4% due

to efforts to focus on cost reductions through investing in manufacturing equipment tobattle increasing commodity costs.

SG&A- is calculated as a historical average of the company, and projected for that time.

Dep. & Amortization- is calculated as a historical average of the company, and

projected for that time.

Working Capital (% Sales)is calculated with the balance sheet assumptions on next

page

Methodology: Discounted Cash Flow


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7/19

Deriving the Weighted Average Cost of Capital

The formula for WACC is the following below:

The first step that must be done is to calculate the after-tax cost of debt, which is done bydetermining the total debt and the interest paid on that debt. The rate interest is the cost

of debt, which for Tootsie Roll were its industrial bonds which according to Corner Stone

Capital is a Cumulative rate of 3.95%. From there you multiply the weighted average cost

of debt by one minus the tax rate to find the after-tax cost of debt.

The cost of equity is derived with the following formula:

The beta was calculated by taking a regression of the 60 month historic share price of

Tootsie Roll and the S&P500, which as shown below the beta turned out to be around .91.

The equity risk premium is based on the standard average, estimated to be 6.1%. The risk

free rate used is the 2.27% and was

sourced from the federal reserve website.

The values combined of cost of debt and

cost of equity to get the WACC of 10.4%.



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Implied Share Price Calculation

The enterprise value is calculated

in a series of steps that are

produced to the right. This method

uses the exit multiple, so the firstthing that needs to be determined

the exit multiple, which was

EV/EBITDA for Tootsie Roll which

is 16.4. You then multiply it by the

terminal year EBITDA metric, and

get your terminal value, which you

then discount by the discount

factor to get your PV of terminal

value. After this, you finally get your Enterprise Value of $2,192.80 by multiplying yourCumulative PC of FCF by the PV of terminal c.

The equity value is calculated by

subtracting total debt from

enterprise value and then adding

cash and cash equivalents. From

here, the equity value is divided by

shares outstanding to get the

share price of $36.54.

The sensitivity analysis shown at

the bottom was formed by using

the data that was calculated above and will be used to provide a range of share prices to

compare.

Implied Share Price

Exit Multiple

0.0 15.4x 15.9x 16.4x 16.9x 17.4x

9.4% 36.25 37.20 38.10 39.11 40.07

9.9% 35.50 36.43 37.31 38.30 39.23

10.4% 34.77 35.68 $36.53 37.51 38.42

10.9% 34.06 34.95 35.79 36.74 37.63

11.4% 33.37 34.24 35.06 35.99 36.86



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Tootsie Roll Industries, Inc., is a smaller player compared to Mars and Hershey whohold a significant amount of Industry Revenues, but is still a powerful competitor for thesebigger companies. Many companies like Mars and Wrigley are private, so they werentable to function as evaluated comparable companies.

Therefore, the following list of companies was chosen to make the following valuation.These companies, like Tootsie Roll, have customers that include wholesale distributors ofcandy and groceries, supermarkets, variety stores, dollar stores, chain grocers, drugchains, discount chains, and many others. They were chosen on a basis of thesesimilarities in specialty retailers, geographic location, and objectives as companies.

Comparable Companies:

The Hershey Companyis an international provider of chocolate and sugar confectionery.

The Companys principal product groups include chocolate and sugar confectionery

products; pantry items, such as baking ingredients, toppings and beverages, and gum and

mint refreshment products. It manufactures, markets, sells and distributes its products

under more than 80 brand names. The Companys two strategic business units are the

chocolate business unit and the sweets and refreshment business unit

Mondelez International, Inc.(Mondelez International) is a snack manufacturing

company. The Company manufactures and markets food and beverage products for

consumers in approximately 165 countries globally. The Company's portfolio includes

nine brands including Oreo, Nabisco and LU biscuits; Milka, Cadbury Dairy Milk and

Cadbury chocolates; Trident gum; Jacobs coffee; and Tang powdered beverage. The

Companys portfolio of snack foods and refreshments also includes 53 brands.

Rocky Mountain Chocolate Factory, Inc.is an international franchisor and confectionery

manufacturer. The Company manufactures a line of chocolate candies and other

confectionery products. As of March 31, 2013, there were six Company-owned, 59

licensee-owned and 294 franchised Rocky Mountain Chocolate Factory stores operating in

41 states, Canada, Japan, and the United Arab Emirates. The Company produces

approximately 300 chocolate candies and other confectionery products, using recipes

developed primarily by its master candy makers.

Snyder's-Lance, Inc.(Snyder's-Lance) is engaged in the manufacturing, distribution,

marketing and sale of snack food products. The Companys products include pretzels,

sandwich crackers, kettle chips, pretzel crackers, cookies, potato chips, tortilla chips, other

salty snacks, sugar wafers, nuts and restaurant style crackers. Additionally, the Company

purchases certain cakes, meat snacks and candies sold under its brands and partner brand

products for resale. The products are packaged in various single-serve, multi-pack and

family-size configurations. The Company's branded products are sold under trade names

owned by the Company.

Methodology: Comparable Companies Valuation


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Once the four companies were chosen, based on the financial data collected I estimated

that EV/EBIT and P/E multiples were most relevant. All values that are derived are based

off of LTM financials which are shown for each company in the form of adjusted income

statement at the back of the report. After collecting the financial data required to calculate

the enterprise value of each company, this formula was used to attain the value:

The equity value was derived by multiplying the market price on November 14th, 2014 by

the number of fully diluted shares outstanding. The companies selected did not have any

preferred stock issued. Below are the following calculations for deriving Enterprise Value.

To calculate the EV/EBIT and P/E multiples, additional financial information was needed.

EV/EBIT requires adjusted EBIT for each company and P/E requires the adjusted diluted

EPS. The values can be found below and the adjusted income statements that are in the

exhibit at the end also display how these calculations were found. By taking half of the

standard deviation of the Median, the range of multiples can also be calculated.

After using the multiples to find the implied enterprise value range, EV/EBIT implied

share price was calculated using the following formulas, and get the result below.

Methodology: Comparable Companies Valuation


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Officially the following precedent transactions valuation methodology should include

merger and acquisition transactions from within the past three years. However, due to the

nature of the companies being acquired and the access to complete information, this

analysis incorporates transactions announced between February of 2008 and this past

May 2014. Therefore, these comparables will be weighed less than the DCF and CompCos.

These following companies were targeted and acquired:

As stated before, these multiples arent as accurate as they could be; some are more

related to the foods industry rather than confectionary snack.

Pinnacle Foods Group LLCis a packaged foods company headquartered in Parsippany,

New Jersey that specializes in the shelf stable and frozen food categories

The Hillshire Brands is an American consumer-goods company based in Downers Grove,

Illinois. It had operations in more than 40 countries and sold its products in over 180

nations worldwide

Canada Bread is the Bakery Products Group of Maple Leaf Foods based in Toronto.

Grupo Bimbo,S.A.B. de C.V. is the largest Mexican-owned baking company, with

operations in the Americas, Asia and Europe. In 2013 generated US$ 13.785 billion in sales

Cadburyis a British multinational confectionery company owned by Mondelz

International. It is the second largest confectionery brand in the world after Wrigley's.

Kraft Foods Group Inc. is an American grocery manufacturing and processing

conglomerate headquartered in the Chicago suburb of Northfield, Illinois.

The William Wrigley Jr. Companyis a company headquartered in the GIC in Goose

Island, Chicago, Illinois that was originally selling products such as soap, baking powder.

Mars, Inc.is an American global manufacturer of confectionery, pet food, and other food

products with US$30 billion in annual sales in 2012, and is ranked as the 3rd largest

privately held company in the United States by Forbes.

Methodology: Company Mergers & Acquisitions


12/19

After the comparable M&A transactions were identified, I proceeded to the next step of

calculating relevant valuation multiples. The multiples selected were EV/EBIT,

EV/EBITDA, and EV/Sales.

The EV/EBIT requires adjusted EBIT for each company and the EV/EBITDA requires the

adjusted EBITDA. The values can be found in the exhibit section in the back. By taking half

of the standard deviation of the median, the range of multiples are calculated.

After using the multiples to find the implied enterprise value range, EV/EBIT implied

share price was calculated using the following formulas:

Utilized below is the control premium which was derived from the 2013 Capital Cube

report for the food processing industry and was found to be 21%. Although it is not the

same industry, it was approximated to be around the same. As a result, the average price

is from $18.21 to $22.4 for each of the methods.

Methodology: Company Mergers & Acquisitions


13/19

From the resulting methodologies, the one year price target is calculated by taking the

weighted average of the median prices. The weights were assigned based on the

confidence that was placed into each valuation method.

As the CompM&A assumptions werent as ideal, I only gave 10% weighting to the threemultiples. The DCF was based on solid assumptions, and the CompCos were estimated to

have reliable assumptions as well.

All in all, Tootsie Roll should be looked into again in the future to possibly look into either

acquiring more companies for more growth domestically and especially internationally.

As the synergies would be high, Tootsie Roll might consider it an option to be acquired as

well.

Valuation Summary


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The National Confectioners Association (NCA) Expanding the Dimensions of

Confectionery: A $10 Billion Opportunity

http://www.candyusa.com/PerformanceInsights/content.cfm?ItemNumber=1442&navIt

emNumber=4499

The 20 year Treasury bond risk free rate of 2.27%

http://www.federalreserve.gov/Releases/H15/data.htm

Beta and company information

https://research-valueline-

com.ezproxy.bu.edu/secure/research?#sec=company&sym=TR

Tootsie Roll Industries, Inc. Form 10-k annual filing.

http://www.tootsie.com/financials/

Cost of Debt

http://www.cornerstonecapitalcorp.com/industrial_revenue_bonds.aspx

Sugar Tariffs

http://business.library.wisc.edu/resources/kavajecz/10_Fall/Tootsie%20Roll_Report.pdf

2.6% size premium for small stock

https://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociat

es/AnalysisSizePremium.pdf

Hershey Form 10-k annual filing

http://www.thehersheycompany.com/investors.aspx

IBIS World Candy and Chocolate Production Industry Reports

http://clients1.ibisworld.com.ezproxy.bu.edu/

Works Cited
http://www.candyusa.com/PerformanceInsights/content.cfm?ItemNumber=1442&navItemNumber=4499http://www.candyusa.com/PerformanceInsights/content.cfm?ItemNumber=1442&navItemNumber=4499http://www.federalreserve.gov/Releases/H15/data.htmhttp://www.federalreserve.gov/Releases/H15/data.htmhttps://research-valueline-com.ezproxy.bu.edu/secure/research?#sec=company&sym=TRhttps://research-valueline-com.ezproxy.bu.edu/secure/research?#sec=company&sym=TRhttps://research-valueline-com.ezproxy.bu.edu/secure/research?#sec=company&sym=TRhttp://www.tootsie.com/financials/http://www.tootsie.com/financials/http://www.cornerstonecapitalcorp.com/industrial_revenue_bonds.aspxhttp://business.library.wisc.edu/resources/kavajecz/10_Fall/Tootsie%20Roll_Report.pdfhttps://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/AnalysisSizePremium.pdfhttps://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/AnalysisSizePremium.pdfhttps://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/AnalysisSizePremium.pdfhttp://www.thehersheycompany.com/investors.aspxhttp://www.thehersheycompany.com/investors.aspxhttp://clients1.ibisworld.com.ezproxy.bu.edu/http://clients1.ibisworld.com.ezproxy.bu.edu/http://clients1.ibisworld.com.ezproxy.bu.edu/http://www.thehersheycompany.com/investors.aspxhttps://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/AnalysisSizePremium.pdfhttps://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/AnalysisSizePremium.pdfhttp://business.library.wisc.edu/resources/kavajecz/10_Fall/Tootsie%20Roll_Report.pdfhttp://www.cornerstonecapitalcorp.com/industrial_revenue_bonds.aspxhttp://www.tootsie.com/financials/https://research-valueline-com.ezproxy.bu.edu/secure/research?#sec=company&sym=TRhttps://research-valueline-com.ezproxy.bu.edu/secure/research?#sec=company&sym=TRhttp://www.federalreserve.gov/Releases/H15/data.htmhttp://www.candyusa.com/PerformanceInsights/content.cfm?ItemNumber=1442&navItemNumber=4499http://www.candyusa.com/PerformanceInsights/content.cfm?ItemNumber=1442&navItemNumber=4499


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Exhibit 1: DCF


16/19

Exhibit 2: Working Capital Projections


17/19

Tootsie Roll Industries, Inc. Reported Income Statement

Prior Current

*In Millions Fiscal Year Ending December 31 Stub Stub LTM

2011 2012 2013 9/28/2013 9/27/2014 9/27/20

Sales $532.500 $549.870 $543.380 $406.881 $404.726 $541

COGS $366.260 $366.550 $351.900 $265.672 $256.943 $343

Gross Profit $166.240 $183.320 $191.480 $141.209 $147.783 $198

SG&A and other $108.280 $114.690 $120.100 $87.620 $85.767 $118

EBIT $57.960 $68.630 $71.380 $53.589 $62.016 $79

Interest Expense ($2.940) ($5.530) ($13.100) ($7.401) ($4.865) ($10.

Pre-tax Income $60.900 $74.160 $84.480 $60.990 $66.881 $90

Income Taxes $16.970 $22.160 $23.630 $17.509 $21.958 $28

Noncontrolling Interest - - - - ($0.352) ($0.

Net Income $43.930 $52.000 $60.850 $43.481 $45.275 $62

Effective Tax Rate 27.87% 29.88% 27.97% 28.71% 32.83% 31.

Weighted Avg. DilutedShares $63.260 $62.320 $61.420 $61.487 $60.668 $60

Diluted EPS $0.69 $0.83 $0.99 $0.71 $0.75 $

Adjusted Income Statement

Reported Gross Profit $166.240 $183.320 $191.480 $141.209 $147.783 $198Non-recurring Items inCOGS - - - - -

Adj. Gross Profit $166.240 $183.320 $191.480 $141.209 $147.783 $198

% margin 31.22% 33.34% 35.24% 34.71% 36.51% 36.

Reported EBIT $57.960 $68.630 $71.380 $53.589 $62.016 $79Non-recurring Items in

COGS - - - - - Other Non-recurring Items - $0.850 $0.970 - $2.380 $3

Adjusted EBIT $57.960 $69.480 $72.350 $53.589 $64.396 $83

% margin 10.88% 12.64% 13.31% 13.17% 15.91% 15.

Depreciation &Amortization $20.496 $21.695 $23.085 $17.137 $18.066 $24

Adjusted EBITDA $ 78.46 $91.175 $95.435 $70.726 $82.462 $107

% margin 14.73% 16.58% 17.56% 17.38% 20.37% 19.

Reported Net Income $43.930 $52.000 $60.850 $43.481 $45.275 $62Non-recurring Items inCOGS - - - - -

Other Non-recurring Items - $0.850 $0.970 - $2.380 $3Non-operating Non-rec.Items - - - - -

Tax Adjustment - - - - -

Adjusted Net Income $43.930 $52.850 $61.820 $43.481 $47.655 $65

% margin 8.25% 9.61% 11.38% 10.69% 11.77% 12.

Adjusted Diluted EPS $0.69 $0.85 $1.01 $0.71 $0.79 $

Exhibit 3: TR Reported & Adjustd Income Statement


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Exhibit 4: CompCo Adjustd Income Statement


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