The Business of Candy

Join Motley Fool senior analyst Asit Sharma and host Emily Flippen as they break down the business of candy in this episode of Industry Focus.

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This video was recorded on Oct. 26, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, October 26, and I'm your Consumer Goods host Emily Flippen. Today I'm joined by Motley Fool Senior Analyst Asit Sharma, and we have a fun Halloween-themed show planned today, courtesy of longtime listener Levi Waddell and I hope I'm pronouncing your name correctly. Who tweeted at us and asked, could we get a show for the public Candy companies in honor of Halloween? We can.

Asit Sharma: I'm going to take a stab at the pronunciation. I think it's Levi Waddell, but that's just what I think so Levi [laughs] let's know. Emily, I got to say what a sweet topic for consumer good show.

Emily Flippen: It is fun because it's one of those topics that we can really only tackle here on the consumer goods show. To be honest with you, I know that we've had some conversations around candy companies in the past, but it's not a particularly, I guess, maybe attractive industry honestly. Not a lot of analysts spend their time looking at candy companies. For the companies out there that are publicly traded in this space, they tend to be part of bigger consumer packaged goods businesses. Although there are a couple of pure-plays and we'll get to those.

Asit Sharma: This is an industry that you would think might have some legs because candy has a never ending demand, especially from the young with Savvy Branding and the use of modern technology. It seems like it could be a great business, a fast-growing business. But over time that tends to be not the case, but this is good that Levi brought up this idea because sometimes you need to work through a few examples to understand why it's prudent to avoid investing in a certain sector or industry, and I think our thesis today is that it's better to eat candy than to invest in it. But Emily, getting into the business of candy, you mentioned to me few big-picture things that turned you away from this sector. For example, it's a low-margin business and it's a commoditized business. Although as I mentioned, some candy can really benefit from great branding and strong brand following. What other things about the candy business, don't you like?

Emily Flippen: Yes, as you mentioned, it tends to be a very low-margin because of how commoditized it is. While I think we'll talk about it today, everybody has their favorite candy. When push comes to shove, if that favorite candy of yours is four times the price of the next best thing when you walk into, say, a gas station or grocery store, are you really going to pay that much more for the branded candy? I think for most consumers the answer's no. They very much view candy as substitutes for one another. It causes the business to have a challenging economic profile, while again, not notoriously unprofitable, just very low margin, and you combine that with what I consider a relatively short shelf-life. It's not like milk or eggs which are much shorter, but we still have expiration date, as well as just constantly trying to keep up with the changing consumer taste and preferences for different foods, for different flavors. A lot of research, a lot of development, a lot of time and money to make what it's ultimately a pretty low margin candy.

Asit Sharma: I think out of all the factors you mentioned, that first one sticks in my mind is the big no in this business, when you are selling candy at any type of still, you have to have two commodity in bulk, sugar, and much of the time you need access to cocoa. To be able to pull these products into your manufacturing environment, it takes a lot of capital. This is not the business that a small Upstart can enter and succeeds in a rapid fashion. That's why we see so little change in the checkout aisle of our grocery stores, which is the prime place where I keep up with candy trends. Although in my Harris Teeter there is a whole half an hour devoted just to candy. I think another half I'll devote just to chocolate and chocolate bars. But you'll notice the brands that have been around since the '70s are still the bands that have that space today and that's just because it is hard to run this business profitably when you're buying cocoa and sugar in bulk. Many times on futures contracts, not the type of contracts that we know in the futures and commodities markets that traders play with. But real futures contracts where you're paying for delivery of a commodity some 6-9 months to a year ahead of time. This business takes a lot of capital and there's not a bunch of profit in it at the end of the day.

Emily Flippen: Let's talk about some of the businesses that are managing to make somewhat of a profit and the place you have done for a while. I don't remember if we did it for previous Industry Focus episode or if this is just a side of desk conversations I had a number of years ago. But I remember Jason Moser talking to me about the fact that he was shocked. Tootsie Roll was a public company and at the time, I was also shocked a year that Tootsie Roll was a public company or it's just a Tootsie which I believe is the name of the business itself. But this is one of the very rare pure-play candy companies on public markets today. I think investors just forget that it's out there in the first place. This is the business that makes not only Tootsie Rolls, but they also have dots, junior mints doubled bubbles, blow pops. At a fun business, although it has not necessarily been the most exciting investment.

Asit Sharma: Sure. Emily, I only know one person in the investment community that even follows this company and that is a fellow Fool TMFCop, Rich Duprey. He knows this company pretty well. But I scratch my head to find other analysts at the Fool or people on Wall Street that follow it. But this company has been in business since the 19th century. It is in its present form, I think since the 1930s. But the story behind this is that a company which was founded for the title manufacturer, was purchased by another family, the Gordon family, and that was in the 1930s. Now, the business didn't change very much from its founding up until about the 1960s. That's when Ella Gordon and her husband Melvin Gordon, inherited the company from their family. Actually inherited a controlling interest. I don't know if they bought the whole thing. But this couple run Tootsie Roll for 53 odd years before Melvin Gordon passed away and Ella Gordon took over as CEO. Now in all this time what do we have, we've got a company that's only valued at two billion dollars. It's got revenue of about 505 million on a trailing basis or annual revenue of roughly half billion dollars and net profit margins that range between six and 10 percent. This is such an interesting story because to me, it's an excellent opportunity if you own this iconic brand to participate in a whole new wave of marketing, to invest a lot, maybe being on TikTok and lead to have all kinds of cool brand extensions. We see the bigger candy companies, which we're going to talk about in the second, doing this with a lot of their brands. But Tootsie Roll has remained stayed in Stover. But it's got this great, I think, perennial demand attached to it. But something happened last, actually I felt this was last summer, actually in January, something interesting happened to this stock in January. What was that?

Emily Flippen: Yes. There was a bit of a, should I call it a meme stock around it. We're talking about retail traders targeting in particular companies that are maybe overlooked under valued businesses. I have maybe just been forgotten about by traditional media and yeah, Tootsie Roll was a part of that experience actually. Interestingly enough, it had a pretty great, I guess, 40 percent run-up in January. As you mentioned, it's really a typical for this business which is relatively flat against S&P 500 over the course of its history as a public company.

Asit Sharma: I think this was the only stock during the meme-stock price. I know it's still like comes in waves. People aren't finished yet with trying to push meme stocks. This was the one that caught my interest earlier this year just because it didn't make any sense. I mean, this is such a sleepy company, but then when you think about it, maybe it's the perfect candidate to isolate has a small capitalization Wall Street bets. I think they were the ones that catalyzed it could put a lot of attention, a spotlight on this. Short interest briefly stock shot up on the stock which made no sense at all. Maybe because as you pointed out, it's not really been this huge performer. It's not like the company is overvalued. Nonetheless, short interest shot up and it had a brief flare ups and downs in the limelight and I think things now are back to normal. But going back to this idea that it's a quiet company that doesn't do much to promote itself for it's brands. Ella Gordon, she's very media shy famously, she is one of the few CEOs on Wall Street who doesn't give any interviews or sit in after earnings to talk with investment analysts, you won't find any earnings calls, transcripts on Tootsie Roll. I looked and could only find two Wall Street investment firms that even follow this company, neither had updated their guidance since 2016. What does this mean for you as investor? 

Means that it's really, really difficult to get any type of forward guidance on the company. Personally, myself I do look at trailing data when I think about what a company should be valued at, but I'm more focused on what's going to happen in the future. It's really hard for me to try to understand a companies value without knowing, hey, what does that cash flow look like 12 months from today? Given everything else I know about the company, one of the assumptions can I make to try to extrapolate a few years forward? This is such a closely guarded company in terms of information. I think that's something that's held the stock back. Perhaps the fact that they don't really want to talk about their performance where they are investing and if you read through their financial statements, they don't reveal a lot of additional information, they seem to give or provide the minimum that they can. However, this doesn't mean that Tootsie Roll is a stable annuity business in every type of climate. They've had some rough weather recently, haven't they, Emily?

Emily Flippen: Yeah, they have. It's it's been challenging, I think for Tootsie Roll to get out of its previous mindset, if you will. I guess their legacy products and we headed into the pandemic, we experienced a time where a lot of foot traffic into the retail sales channels that have been responsible for the majority of this stable demand really fall off. 2020 was certainly a challenging year for the business. But that has rebounded somewhat as foot traffic into these channels have come back heading into 2021. Sales are somewhat normalizing this year, but even accounting for the weirdness that it was 2020. This is still a business that hasn't grown sales really at all over the past 5-10years. I want to call it a stable performer. But when you are able to grow sales at a base level rate, I would just say slowly declining performer.

Asit Sharma: Yeah, which makes you wonder why buy the stock at all. Over the last 10 years, the total return for Tootsie Roll is just 88 percent. That's a cumulative number versus a total return of 356 percent for the S&P 500 on an aggregate basis over the same period. But there may be an idea here for some investors before we move on. Maybe this is a great dividend investment because they do what they do very well and don't try to reach much, they don't have much ambition to grow this company. It does issue a quarterly dividend that has a small yield of one percent. But Tootsie Roll offers an annual stock splits on 103 percent to 100 basis. That means basically you're getting a three percent stock dividend every year or a four percent yield when you consider the extra stock you get. This is unusual in this day and age. I remember when I first started out investing, it used to be much more common to see stock dividends that were annual in the form of these small stock splits. But a rarity these days maybe make sense for this type of business. Before we move on, the only caveat I'll say here is the Gordon family does not really understood what the succession plan will be after Ella Gordon decides to retire. She is now in her 80s. That might board the idea that this is that safe annuity-type dividend investment. Simply because we don't know what is going to happen next or how the board is treating succession.

Emily Flippen: Well, I have to say as a big fan of Junior Mints myself, I hope that whatever is next for Tootsie Roll, I'd be really interested to see if we have somebody come in who has a different vision for the business and not that anything is wrong with being to point and newly style company. But at the same time I think this is still a publicly traded company. Now, let's live up to that name of being a publicly traded company. Let's talk a bit about what our expectations are, what our goals are. Whoever comes in next, my hope is that they have a grander vision than how Tootsie Roll exist today. That's purely because of my love for Junior Mints.

Asit Sharma: Agree.

Emily Flippen: Well, let's talk about Nestle a little bit. Nestle is one that investors are probably familiar with, with their water business. They obviously have a conglomerate style to them. The different product lines that they're in. But they're also the creator and owner of candy and confectionery brands like Kit Kat, Smarties, Aero bars, which I think are mostly popular in Europe. Nestle is certainly a player in this space, even if the confectionery aspect of their business is much smaller than their overall CPG focus.

Asit Sharma: Sure. They sold off their US confections operations to be Italian company Ferrero, which is well known for its chocolates in 2018. In this shift that we're seeing with a lot of consumer goods entities to go for healthier products. It's a big company, $351 billion in market capitalization, $92 billion in trailing 12-month revenue. That makes it the biggest consumer goods packaged or CPG conglomerate on the planet. Trailing 12-month candy revenue, although a fraction of that 92 billion. Is still a big number, seven billion bucks in candy revenue. The company has a net profit margin that ranges between seven and 11 percent. Here, not much to say because I think Nestle is more in a downshift gear with candy. I did want to point out one thing, Emily. You mentioned that water business, it's a big business in and of itself. It's about eight billion dollars in revenue. They've drawn a lot of flak over the years from the fact that being this huge conglomerate, they extract a lot of water from local communities. 

Now they have the right, they buy the rights. But then they take water from communities, bottle it and sell it around the US and the world. It seems like they're constantly under fire for this as maybe an unsound environmental practice because of the water rights issue and water scarcity, and also because of the footprint that plastic bottles create. I wanted to give them a little credit today for doing something that's environmentally friendly. They're prototyping a paper-based wrapper on their smartest confectionery line that's going to reduce their plastic waste on this line significantly. I was interested in this because I had been in the publishing industry, in the print industry specifically for many years on a finance team for a manufacturer. We were constantly experimenting with the types of papers that could run through our machines. This is essentially what Nestle is doing. It's using the same machines that produce the plastic wrapping for Smarties, but using now a paper-based wrapper that they hope can reduce a lot of waste. We should say here though, these aren't the Smarties that you might be thinking about. That is the that delectable, multi-colored, sweetened tart Smarties that we all grew up with here in the States. These are a chocolate confection that's sold widely in Europe. I've never tasted a European Smartie, but that's actually the candy we're referring to here.

Emily Flippen: I haven't either. I have a very hard time imagining what a chocolate Smartie looks like. I'm a big fan of the regular Smarties, what I call regular Smarties, the American Smarties. But are essentially just colored sugar packaged into little pellets. Hearing that was certainly interesting. I will say their decision to sell off their US based confectionery business was interesting. Part of the reason why is because they wanted to focus on healthier products and putting the ESG concerns aside, it's just a representation of those changing consumer trends. I think the demand for some candies is always going to be there. It's always going to be a treat. But I think they saw the inevitable shifts that were coming their way in terms of just on a day-to-day basis, demand for confectionery products versus, I could just say, healthier products or what are branded as healthier products.

Asit Sharma: It's true. I think the next company that we're going to talk about has been more in the mode of let's rework what we've got rather than sell them off. This is another giant formed out of the old Kraft Heinz Company, before it was Kraft Heinz actually [laughs]. We're going to talk now about Mondelez symbol, MDLZ, which was formed when the then management team decided that they would take what they call the Power Brands out of Kraft. They would separate the grocery and Power Brands business. Power Brands being at that time mostly cookies and candy. [laughs] Those were the leading Power Brands. The funny thing about Mondelez is that they spent months and months coming up with the name. I still don't think this name has caught on in the larger society, Emily. I feel like if I walked out on the street after we finish taping and ask someone, do you know what Mondelez is, I would just draw a blank stare. [laughs]

Emily Flippen: But they do have some brands that I bet if you went to the streets and ask them people, "Hey, do you know Oreos? Do you know Tate's Bake Shop. Do you know Cadbury or Toblerone?" A lot of people would smile and nod at you, which is exactly what Mondelez is best known for. To your point, I think they've done a good job of taking what they have and then reworking it to be attractive to a market that would otherwise maybe not buy those products as frequently. Tate's is a great example. They're indulgent cookies, but they're thinner, they're smaller, they're in smaller packages branded and presented in a way that is a little less guilt-free, I suppose, and going through buying the package of different cookies or in this case maybe compared to Oreos. Whereas Oreos has managed to really make itself standout by it's constant rebranding. The seasonal Oreos almost make it an experience as opposed to just indulgence that you make on a daily basis.

Asit Sharma: So many good points there, Emily. Absolutely. What Mondelez is doing with Oreos is what I feel Tootsie Roll Industries should be doing with Tootsie Roll and its other brands. So much experimentation. You mentioned the packaging that is really going along with our shift and preferences. They are repackaging their candies into smaller, indulgent packets. That's a win-win for them because it is a way to act like they're being a healthier choice. But at the same time, they make a much higher margin. Whenever any candy company or beverage company sells a unit in a smaller package, that's higher profit margin for them. That's great. Now we should say here that Mondelez, which has revenue of 27 billion and 11 billion bucks in trailing 12-month candy revenue. It is a company that overtime is focusing on its chocolates confections, but is also working on healthier lines outside of that part of the business in its biscuits, cheese, and grocery lines. Now, you may think biscuits refer to something different than they are. This is a company that uses the British term biscuits to refer to basically cookies and crackers. In Mondelez's categorization, Oreos, are biscuits.

Emily Flippen: Before we wrap up here, we have to talk about the, I don't want to say notorious, but why not, let's go with it, notorious See's Candy, the business that Warren Buffett is a huge fan of, which the business Berkshire Hathaway purchased, I believe. Goodness. I'm not positive of the date, but it's been a very long time. Yes, 1972, I see you have it in your notes. In 1972, See's Candy and they're best known for their make of chocolate confections. Things like truffles or chocolate balls. I have to say, I'm not a fan [laughs] of See's Candy, especially when I put it in comparison to things like Kit Kats, Butterfingers, or American Smarties.

Asit Sharma: Oh my. Emily, since we're talking about the British name for biscuits, I think we're going to have to use a British pronunciation here. I think you're introducing an element of controversy in this podcast. [laughs] I'm going to go with you out here on a limb. I don't think See's is the greatest candy in my personal opinion, but I am going to give them some props for this. I am very definitely an optimistic person. I tend to wake up on the happy side of the bed, but I have my moments. I have my days and occasionally I have my weeks and when I'm in a mood, there's nothing I like more than a whole pint of ice cream to myself or a box of chocolates. I won't say that I sit and weep over a box of chocolates, but I will certainly sit and maul over a box of chocolates when I'm down and I think See's Candy's good for that. But I ask you, can you even buy See's in a grocery store? Don't you have to order this via the Internet or [laughs] catalog. I hate to make this sound like such an old-timey candy company, but there it is. I've never seen it in the stores, at least here in the South world [laughs].

Emily Flippen: Neither have I and I've always have imagined it as a premium option. You go out of your ways to indulge in See's Candy. But you did note this was an investment that Berkshire Hathaway and Buffett made for, I believe it was $25-30 million. At the time, Buffett has been interviewed, say he was balking at the price of it, but it's generated over a billion dollars in profits for the entire business and it's a small part of Berkshire Hathaway, obviously. But it is a fun part of it too. I think it represents the mindset of Warren Buffett well for the types of investments he makes.

Asit Sharma: Absolutely, and I think it's a great note to end on because maybe this is the business thesis here. If you have the capital, let's say you're the Gordon family and you can own and control Tootsie Roll or if you're Warren Buffett and Berkshire Hathaway can purchase this candy company, lock, stock, and barrel. Then a candy company can be a great business for you over the decades. As See's Candy has been for Berkshire, as Tootsie Roll industries has been for the Gordon family, then you can just reap those pre-tax profits without a lot of investment and just enjoy putting See's Candy out at your annual shareholder meetings. It's always visible [laughs] on the table at Berkshire's Annual shareholder meeting. They are notorious for hawking their products for the companies that they own. Maybe that's the investment thesis here. First, amass several millions or hundreds of millions in capital, then invest in the candy business.

Emily Flippen: Well, for the investors out there listening, hopefully, we're investing a little bit in candy for this holiday season coming up headed into Halloween. I know, living in an apartment complex with very little kids nearby, will get no tricker treaters, but I will still buy myself some candy anyway and indulge it personally. I have to ask though, Asit, before you head out: What's your Halloween indulgence? Let's say you have to have one piece of candy headed into Halloween, what's your favorite go-to?

Asit Sharma: It's going to be an indulgent, small miniature wraps Snickers bar. But I'll be honest here, Emily, it ain't going to be just that one piece. It's going to be like six or eight or 12 before [laughs] the night is over. I really love that. I don't buy any candy bars during the year, but I find myself compulsively eating those through the evening and I will definitely be doing that on Halloween and yourself before we head out of here.

Emily Flippen: I will do exactly the same. I will not limit myself to just the Snickers, so I will have to throw Twix in there as well. One time of the year I get Twix if you stick them in the fridge for just a little bit before you eat them, it makes them nice and chewy, which is exactly how I like my candy bars.

Asit Sharma: Excellent recipe.

Emily Flippen: Well, listeners that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say, hey, shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned. So don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work by the screen today for Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on!