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3 sweet candy stocks for soured investors
After wrestling with a tough market, some investors are turning to candy stocks as havens. All this attention has left some candy stocks too expensive. But three are worth tasting.
By Robert Walberg
Halloween is just over a week away, and, if youre like me, youve already started to load up on candy and other treats for the kids. The National Confectioners Association says candy sales jump by more than 100% from the norm in the two weeks leading up to Halloween.
The association also expects candy sales this year to top the $2 billion mark, a modest increase from $1.98 billion last year. Apparently, the Atkins craze hasnt slowed down our appetite for sweets. While thats not good news for the waistline, it is good news for candy companies.
In a year when much of the market has struggled, candy companies have delivered tasty results for investors. The average gain this year for Cadbury Schweppes (CSG, news, msgs), Hershey Foods (HSY, news, msgs), J&J Snack Foods (JJSF, news, msgs), Rocky Mountain Chocolate Factory (RMCF, news, msgs), Tootsie Roll Industries (TR, news, msgs) and William Wrigley Jr. Co. (WWY, news, msgs) is a delicious 18%. Even backing out the oversized 67% gain recorded by Rocky Mountain Chocolate, the group is up an average of 8%, compared to the roughly 5% decline for the Dow Jones Industrial Average.
One reason for the industrys relative success is its history of steady, dependable earnings growth. Growth might not be spectacular, but in a year when investors have had to digest soaring oil prices, rising interest rates, sluggish job growth, war in Iraq and electoral uncertainty, low risk and stability proved to be mighty appealing.
For the balance of the year and into early 2005, candy companies should continue to benefit from their status as safe havens. This is especially true if analysts maintain their estimates for 2005. They now expect average earnings growth of 12.6%.
Could cocoa prices cause problems?
But there are risks to the earnings outlooks, none bigger than rising commodity prices. Kraft Foods (KFT, news, msgs) recently blamed rising commodity prices for trimming 9 cents from its third-quarter earnings. While cocoa prices remain soft due to abundant supply, its unclear how the hurricanes affected the peanut crop.
Considering the oversized gains recorded by the group and valuations that in some cases are getting a bit rich, any sign of negative news could spell trouble.
The stock most vulnerable to bad news, real or perceived, is probably Hershey. Up over 21% year-to-date, Hershey trades at 23 times estimated 2004 earnings of $2.02 and about 21 times projected 2005 results of $2.23. These multiples represent moderate premiums to the group. The companys price-to-sales ratio is among the highest in the industry. Hersheys premium valuations are partly justified by its stellar earnings track record, solid management team and impressive 41.8% return on equity.
But disappointments will cause investors to take a bite out of that premium. Considering the unknown regarding commodity pricing, it seems an unnecessary risk to take.
Similar concerns haunt Tootsie Roll. The stock trades at nearly 24 times and 22 times estimated 2004 and 2005 earnings, respectively. While Hershey can justify its premium multiples given stellar performance, Tootsie Roll cant. The company has delivered below-industry growth for more than a year now, and next year looks to be no different. Maybe thats why the stock is the only loser in the group, down about 14% this year.
Though its stock chart suggests that Tootsie Roll is probing for a near- to intermediate-term bottom, sluggish, below-industry sales and earnings growth, combined with premium valuations, argue against any sustained price advance.
Up in the thin air
Our third company to avoid is William Wrigley Jr. Co. The company isnt in the chocolate and candy business. Chewing gum, however, is a Halloween staple, and so it made my list. Like Hershey, Wrigley is a well-run profit machine with an enviable track record of consistent earnings growth. Its earnings are projected to jump 11% this year and next. A nice dividend yield of 1.48% and return on equity of 24.4% also are compelling reasons to consider investment in the nations No. 1 gum company.
Unfortunately, Wrigley is fairly priced -- if not slightly over-priced. It trades at nearly 29 times and 26 times estimated 2004 and 2005 earnings and four times trailing 12-month sales.
Two exciting smaller stocks
Where the industry does offer some excitement is in the two smaller companies -- J&J Snack Foods and Rocky Mountain. J&J sells everything from soft pretzels to cookies, and Rocky Mountain focuses on premium chocolate candies. J&J's stock is up 13% this year and Rocky Mountain is up 67%. Combined, the two offer investors a nice mix of value and growth.
Trading at about 17 fiscal 2004 earnings, due out soon, J&J is a nice value. When you back out the $4.68 per share in cash, the stocks value is a much more compelling, 15.5 times. The price-to-earnings ratio drops to an even more attractive 13.6 times based on estimated fiscal 2005 results. Whats surprising is that the multiple is so low even though the companys average annual earnings growth rate of 12% is in line with or slightly above the industry norm. Meanwhile, the stocks price-to-sales multiple of 0.98 is well below the group. Assuming the company merely delivers on its sales and earnings targets, the stock should make a run at the $50 to $51 area over the next six to 12 months.
Rocky Mountain isnt the value that J&J is, but you wouldnt expect that from a company that's expected to grow earnings by 22% in fiscal 2006. Nevertheless, trading at about 19 times fiscal 2005 estimates and only 15.7 times 2006 projected earnings, the stock is cheap relative to its growth potential. (The fiscal year ends in February.) Rocky Mountains margins, return on equity and dividend yield (1.83%) are also among the industrys best.
The big question for this company is whether management can continue to deliver top- and bottom-line growth as it expands. Sales over the past 12 months were a relatively puny $22.3 million. With a market cap of only $54.9 million, Rocky Mountain isnt for conservative investors. But if management continues to deliver the goods, risk-tolerant investors should be rewarded with another big year as the stock has upside potential to the $16 to $17 range.
And a great, really cheap stock
My final play in this area is the larger, more well-known Cadbury Schweppes. While much of the companys business comes from its beverages group, Cadbury also has a large confectionary unit. Trading at nearly 14 times and 12 times projected 2004 and 2005 results, Cadbury is downright cheap. Investors also get a robust 2.8% dividend yield and a company with a return on equity of 24.3%. Thats a nice overall package and an especially nice balance to the two smaller favorites.
| How the candy companies compare |
Stock | Price | FY04 Earnings estimate | FY05 Earnings estimate | YTD % Gain/loss | | Cadbury Schweppes (CSG, news, msgs) | $32.45 | $2.41 | $2.65 | 8.6% | | Hershey Foods (HSY, news, msgs) | $46.61 | $2.02 | $2.23 | 21.1% | | J&J Snack Foods (JJSF, news, msgs) | $43.07 | $2.47 | $2.83 | 13.2% | | Rocky Mountain Chocolate Factory (RMCF, news, msgs) | $12.90 | $0.67 | $0.82 | 66.9% | | Tootsie Roll Industries (TR, news, msgs) | $30.10 | $1.27 | $1.37 | (13.9%) | | William Wrigley Jr. Co. (WWY, news, msgs) | $63.34 | $2.21 | $2.46 | 12.7% |
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At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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