NYSE:TR TOOTSIE ROLL INDUSTRIES, INC
Sector financial performance:
This company, focusing on manufacture and sale of confectionery products by wholesale and retailers, was grouped into chocolate &confectionery sector of Candy industry.
It seems sales volume is declining for those chocolate manufacturers in this sector probably as a result of generally declining demand in US market. Our data indicates that there are two different stories for traditional in-store retail sales channels and for massive merchandise or online sales channels. Sales pressure seems to be bigger for traditional mall-based store sales (presented an annual decrease of about 3%). Decrease in sales volume seems to be slower for other manufacturers with diversified sales channels (presented an annual decrease of 1%), a result attributable to retail traffic’s shifting from mall-based stores to mass merchandise stores.
However, we think that another reason that caused a difference may lay in competition in price, which usually significantly relies on margins in different sales channels. After experienced high margins due to low costs for years, companies in this sector started to feel pain brought by rising ingredient costs and labour costs started since 2015. And this is a strong incentive for them to raise selling price and caused huge pressure on margins of their retailers. Obviously, traditional candy stores have the least flexibilities in dealing with the balance between raising price/cutting expenses and thus lose sales.
Our data indicates, however, that while, due to being more flexible to lower price, chocolate companies with diversified retailers experienced less decrease in sales, due to increasing production costs and general pressure on top of wholesale price the companies in both stories have had to endure shrinking margins and profitability. At the current level, the average gross margins for chocolate manufacturers vary between 28% - 36%. They usually spend 24% of the total sales on SG&A and can generate a 13% operating margin.
According our analysis, the sector’s ratios of enterprise price/adjusted EBI ranges 19-52, which is a big gap because of the industry trend discussed above about their retailer types.
It seems the demands for chocolate products of this company have been weak as indicated by challenging situation of its retail customers who have been facing price pressure under intensive competition and increased costs.
For first nine months of fiscal 2018 compared with same period of 2017(ended 20180930)
Organic sales of US market excluding timing of transaction impacts was about flat (less+/-0.6%).
For fiscal 2017 compared with 2016
Organic sales volume/price of US market excluding currency impacts was flat.
Organic sales of US market excluding currency impacts was flat in the first half year of 2017, went down by more than 3% in 2016, up by 1% in 2015, and flat in 2014.We think the brand awareness is critical in this industry but competition among brands also makes sales very sensitive to price.
While the increasing ingredient costs, its gross margins have been improved from around 37% of 2015 and 2014 to above 38% in 2016 as a reflection of raised selling price in 2016, the increasing production efficiency with more capital investment, and cost cutting programs. However, the gross margin went down in 2017/18 to about 36% due to increasing ingredient costs, packaging costs, and labor costs. with increased SG&A%, its operating margin down to about 12% in 2018.
This stock currently has an enterprise price/EBI ratio of about 52. We think the improvement of its margins may not be sustainable and thus may fluctuate as market environment changes. Therefore, this ratio is relatively too high to be explained by its favourable prediction about sales and improved margins. We think it may be still overvalued compared with its peers.
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