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Consumer staples stocks are some of the most valuable ones to own when the market goes into a tailspin on days like Thursday. As the Dow Jones Industrial Average was falling 400 points, Tootsie Roll Industries (NYSE: TR) was near flat for the day.
Tootsie Roll stock has been a unique outperformer during all this market carnage. Shares of Tootsie Roll are up 1% year-to-date, and are up 7% over the past one year. By comparison, the S&P 500 is down 10% in the past year.
Safe and Steady
The reason that Tootsie Roll offers so much relative safety when the market crashes is, at a fundamental level, that its business model is very steady. Tootsie Roll sells confectionery products with brands like its namesake chocolate, plus Andes, Blow Pop, Junior Mints and Charleston Chew.
People tend to buy candy products like these regardless of the swings in the economy. Even when the U.S. enters recession, candy sales don’t suffer much. This is why Tootsie Roll’s sales and earnings continued to grow even during the dark days of the financial crisis.
For example, Tootsie Roll’s total sales grew 1% in 2009. That in itself was a remarkable achievement given the entire U.S. economy was hit with the worst recession since the Great Depression.
Last year, Tootsie Roll’s net sales declined 1%, but it generated 6% earnings growth due to stock buybacks and a meaningful benefit from lower expenses. Tootsie Roll is benefiting from the decline in commodity prices, which has helped lower raw materials costs. And its distribution expenses are down thanks to lower fuel prices.
Plus, most of the revenue decline was because of unfavorable currency translations – a side effect of the strengthening U.S. dollar – but domestic sales still increased for the year.
Tootsie Roll is in good financial position. At the end of the third quarter, the company had a current ratio in excess of 3 times, which means it can cover its short-term debts with its short-term assets more than three times over. Furthermore, its long-term debt to shareholder’s equity ratio is a manageable 20%. This means the company’s debt is under control, and should not inhibit its ability to continue using its cash flow to buy back stock and pay dividends.
Valuation Is Hard to Swallow
While Tootsie Roll is a highly profitable company with a number of popular products and a well-deserved reputation as being a defensive business, investors pay a high price for that relative stability.
Shares of Tootsie Roll trade for 29.5 times last year’s $1.08 in earnings per share. That’s a much higher multiple than the market overall — the S&P 500 index trades closer to 19 times earnings. Since Tootsie Roll isn’t a high-growth company, it’s questionable whether the stock should hold such a lofty valuation.
A low valuation provides what Warren Buffett refers to as a margin of safety, meaning some protection against downside risk. Another valuable margin of safety is a dividend. Again, while Tootsie Roll does pay a dividend, its yield is only 1.1% — that is about half the level of the S&P 500 dividend yield.
Tootsie Roll does grow its dividend. Last year, the company raised its dividend by 15%. That will help its yield catch up to the broader market averages. But even so, it will take years for the company’s yield to rise with such a low starting yield.
A reasonable decline of 10% or more would bring Tootsie Roll’s valuation back to reasonable levels, and it would serve the dual purpose of elevating its dividend yield (since stock prices and yields move in opposite directions). As a result, it seems prudent for investors who want to buy Tootsie Roll stock to wait for it to decline before buying shares.
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