Value Investing

Tootsie Roll Industries, Inc. (TR) – “More Tricks Than Treats”

Tootsie Roll Industries (NYSE: TR) is a producer and marketer of candies and lollipops under the brands Tootsie Roll, Blow Pops, Junior Mints, Andes Candies and others. For years, the bull case has assumed Tootsie’s brands were iconic and “hope” that its  founders would eventually sell the Company at a rich premium. Based on extensive fundamental and forensic research, Spruce Point sees flaws with this thesis and 25% – 50% downside once investors evaluate our compelling research.

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Tootsie dates back to the early 1900s and its brands are withering along with its core customers. Sales haven’t grown in 6yrs and we estimate it is losing market share in North America. Our channel checks reveal it uniformly receives the worst product placement on the shelves (esp. during key Halloween selling season). Tootsie’s products fail to address consumer demand for healthier products, and it has resisted industry self-regulatory movements to limit marketing to children. Early adoption of new FDA labeling requirements show Tootsie has shrunk its serving size, an implicit acknowledgement consumers are eating less candy. Enhanced sugar disclosure requirements now show significant added sugar content to its products. Families and kids take notice: we estimate a box of Junior Mints, a popular Tootsie product, contains 185% of daily added sugar needs.

Tootsie is notoriously secretive about its financials: it doesn’t hold investor conference calls, invite analyst coverage, and has a minimalistic IR website. Its SEC filings omit significant information material to investors’ understanding of its business including: 1) product mix and pricing trends, 2) commodity cost impact to margins, 3) R&D expenditures. Tootsie also inflates its gross margins in a material way by excluding shipping, warehousing, and freight costs. This leads to an 800bps gross margin overstatement. Compare Tootsie’s adjusted gross margin of 31% with peers Hershey and Mondelez at 46% and 39%, respectively, and it’s easy to see that Tootsie is running an inferior candy operation. Even worse, we believe Tootsie has inflated operating cash flow by ~$50m since 2012 though early termination of its split dollar life insurance policy. In essence, Tootsie lent money to these policies for the benefit of its executives, and is now tapping the cookie jar to reclaim funds and boost cash flow.

In our opinion, Tootsie is run for the benefit of insiders, while taking advantage of common shareholders through lavish compensation and excessive perks. Its dual class share structure allows Class B shares controlled by insiders to limit common stock voting control, while the Board is stacked with the CEO’s allies, none of which have experience in the food industry. Insiders have rigged the bonus structure in a way that virtually guarantees the maximum bonus every year, while allowing the top 6 executives to extract ~19% of adjusted SG&A in annual compensation (and grow comp more than 3x the rate of sales). Tootsie offers none of its employees equity or stock options, which virtually guarantees that no one will care about maximizing the share price Download the report to read more.

Executive Summary

Mr. Axler(od)’s Spruce Point Capital Initiates An Activist Short Position In Tootsie Roll

Tootsie Roll Industries, Inc. (TR)

Pay Close Attention: Risk Factor Explosion Today vs. 10yrs Ago

Tootsie no longer offers tours of its main production facility: The only option to see the Chicago plant is a “virtual” tour on the website Tootsie now warns: “negative publicity associated with this type of event, including a product recall relating to product contamination or product tampering, whether valid or not, could negatively impact future demand for the Company’s products”

Tootsie Roll Industries, Inc. (TR)

Undisclosed Asbestos Risk Uncovered Through Freedom of Information Request

Tootsie does not disclose anywhere in its SEC documents that its main manufacturing facility in Chicago is dealing with asbestos removal on an annual basis. Asbestos is a known cancer-causing agent that is transmitted through the air. We hope Tootsie has protections to prevent the asbestos from entering the food.

Tootsie Roll Industries, Inc. (TR)

Asbestos Issues For At Least A Decade

The earliest record we obtained from the EPA was from the end of 2005.

What company needs a decade to deal with asbestos issues?

Is this why Tootsie forbids plant tours, has limited communications with investors, and is stock-piling cash to reserve against potential issues?

Tootsie Roll Industries, Inc. (TR)

Spruce Point Is Short Tootsie Roll (TR) And Sees 25% - 50% Downside

Declining Brands With New Labelling Highlighting Consumption Challenges, Understates Health Impact:

Tootsie dates back to the early 1900s and its brands are withering along with its core customers. Sales haven’t grown in 6yrs and we estimate it is losing market share in North America. Our channel checks reveal it uniformly receives the worst product placement on the shelves (esp. during key Halloween selling season). Tootsie’s products fail to address consumer demand for healthier products, and it has resisted industry self-regulatory movements to limit marketing to children. Early adoption of new FDA labeling requirements show Tootsie has shrunk its serving size, an implicit acknowledgement consumers are eating less candy. Enhanced sugar disclosure requirements now show significant added sugar content to its products. Families and kids take notice: we estimate a box of Junior Mints, a popular Tootsie product, contains 185% of daily added sugar needs

Opaque Financial Disclosures, Overstated Gross Margins And Cookie Jar Accounting Inflating Operating Cash Flow:

Tootsie is notoriously secretive about its financials: it doesn’t hold investor conference calls, invite analyst coverage, and has a minimalistic IR website. Its SEC filings omit significant information material to investors’ understanding of its business including: 1) product mix and pricing trends, 2) commodity cost impact to margins, 3) R&D expenditures. Tootsie also inflates its gross margins in a material way by excluding shipping, warehousing, and freight costs. This leads to an 800bps gross margin overstatement. Compare Tootsie’s adjusted gross margin of 31% with peers Hershey and Mondelez at 46% and 39%, respectively, and it’s easy to see that Tootsie is running an inferior candy operation. Even worse, we believe Tootsie has inflated operating cash flow by ~$50m since 2012 though early termination of its split dollar life insurance policy. In essence, Tootsie lent money to these policies for the benefit of its executives, and is now tapping the cookie jar to reclaim funds and boost cash flow

Undisclosed Asbestos And Worker Safety Issues Revealed Through Freedom of Info Requests:

Bulls think Tootsie may own valuable real estate in South Chicago at its 2m sqft HQ and manufacturing facility. Our property tax record search suggests total asset value of $40-$50m for key domestic properties. Tootsie doesn’t offer plant tours and is quiet on environmental issues in its SEC disclosures. We think we know why. We completed a Freedom of Information request with Chicago’s EPA region and were shocked to learn that Tootsie has been filing annual forms related to asbestos removal. Asbestos is a known cancer-causing agent that is transmitted through the air. We hope Tootsie has protections to prevent the asbestos from entering the food supply and is adequately protecting its workers. Worker safety is an area that Tootsie appears deficient. We filed Freedom of Information requests with the Illinois and Boston OSHA/DOL districts and were dismayed to learn that Tootsie was cited repeatedly over multiple years by OSHA for “Serious” violations related to machine operations and worker safety. Tootsie’s apparent disregard for safety recently lead to a worker at its Cambridge Brands subsidiary having a finger amputated

Article by Spruce Point Management

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