Popoola Oluwasegun Oluwatoyin

Graduate Student Security Analyses Paper

Comparative Valuation Analyses of WRIGLEY WM JR CO (WWY) and

THE HERSHEY COMPANY (HSY)

Investments

December 2007

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Industry Outlook

The confectionery industry is widely viewed as a cash cow not only because of its high liquidity and low

capital requirement but also because of its low debt profile. As a result of its nature, it has been

characterized by large investments in product development and innovation.

Historical Backgrounds

The Wrigley Company (WWY)1 was founded in 1891 and has been led by four generations of the

Wrigley family. Over the years, the company has produced high quality chewing gum and confectionery

products that are great tasting and fascinating to the public as indicated by their financial performance.

WWY which began operation with the introduction of its first two products, Juicy Fruit and Wrigley‟s

Spearmint gums over 110 years now has brands that are sold in over 180 countries and its portfolio of

products includes dozens of innovative brands that provide consumers with a variety of benefits,

including breath freshening, tooth whitening and vitamin delivery. WWY with revenues of slightly over

$5 billion and more than 15,000 employees worldwide has created new confections under these well-

loved brands including mints, breath strips and candies.

The Hershey Company (HSY) on the other hand is the largest North American manufacturer of quality

chocolate and sugar confectionery products with revenues of nearly $5 billion and more than 15,000

employees worldwide. HSY markets such iconic brands as Hershey's, Reese's, Hershey's Kisses, and Ice

Breakers. HSY is the leader in the fast-growing dark and premium chocolate segment, with such brands

as Hershey‟s Special Dark, Hershey‟s Extra Dark and Cacao Reserve. Hershey‟s Ice Breakers franchise

delivers refreshment across a variety of mint and gum flavors and formats. In addition, HSY leverages its

iconic brands, marketplace scale and confectionery and nut expertise to develop and deliver substantial

snacks, including Hershey's and Reese‟s single-serve cookies and brownies, and value-added snack nuts,

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WWY is the world‟s largest manufacturer of chewing and bubble gum.

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including Hershey‟s Milk Chocolate Covered Almonds and Hershey‟s Special Dark Chocolate Covered

Almonds.

Analytics

Comparative Quantitative Analysis

Profitability Ratios

A review of the financial figures of WWY and HSY in the last 3 years shows a mixed performance in the

top and bottom line compared to the industrial benchmarks. Return on Sales averaged2 22.97% and

30.02% while Return on Equity averaged 22.73% and 61.47% in the last 3 years for WWY and HSY

respectively. Particularly worrisome is the fact that WWY could not beat the industry benchmark of

18.9% for return on Assets. HSY is clearly better than WWY in terms of profitability as the profitability

ratios reveal. (Please see Appendix I - IV for details).

Total Revenue
Amounts in Thousands of

5,000,000.00
4,000,000.00
3,000,000.00
USD

Total Revenue
2,000,000.00
1,000,000.00
-
2004 2005 2006
Years

Graph of WWY Revenue Stream in the last 3 years

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Simple average used.

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 Amounts in Thousands of Total Revenue

5,000,000.00
4,800,000.00
4,600,000.00
USD

Total Revenue
4,400,000.00
4,200,000.00
4,000,000.00
2004 2005 2006
Years

Graph of HSY Revenue Stream in the last 3 years

Liquidity Ratios

The liquidity ratios for WWY and HSY will advance the argument that WWY seems to be better in terms

of liquidity. This only buttresses the fear that HSY‟s growth is severely limited by its size as its liquidity

position had weakened considerably owing to the negative working capital. HSY could not meet any of

the industrial benchmarks in this category as Current ratio of 0.98; Quick ratio of .47 and Interest

Coverage of 7.44 at 2006 year end fell below the industrial benchmarks of 1.6; 0.6 and 13.1 respectively.

(Please see Appendix I – IV for details).

Activity Ratios

The activity ratios for WWY fell below the maximum industry benchmarks except the Receivables

Collection period, while HSY faces obvious liquidity problems as its activity ratios are not only above the

maximum industry benchmarks but Working Capital Turnover is negative indicating that HSY is

operating with negative net working capital and overtrading on its available funds. (Please see Appendix I

– IV for details).

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Financial Structure Ratios

The financial structure ratios for WWY are impressive. However, a cursory look at HSY‟s Debt to Equity

ratio which stands at 1.83 compared to an industry maximum benchmark of 1.4 clearly indicates that HSY

may be over leveraged as its debt to equity ratio is seemingly high. (Please see Appendix I – IV for

details).

Industry Statistics as
at December 2006
Long
Term Net
Market Revenue Growth Revenue Dividend Profit Total
Position Capitalization Growth Rate Growth Yield Margin Revenue
1 WWY WWY WWY WWY HSY RMCF WWY
2 HSY RMCF HSY RMCF RMCF TR HSY
3 CZZ HSY HSY WWY WWY IPSU

4 TR TR TR TR PARF.OB TR
5 IPSU PARF.OB PARF. OB IPSU HSY RMCF

Key
CZZ Cosan Limited CL A RMCF Rocky Mt Chocolate
HSY The Hershey Company TR Tootsie Roll Ind
Wrigley WM Jr
IPSU Imperial Sugar Co WWY Company
Paradise
PARF. OB Inc

Source: Yahoo Finance

Comparative Qualitative Analysis

Ownership Composition

The management of HSY is narrowed to a number of mutual funds and institutional investors,

while, a significant chunk is held by the family of the late founder via the Hershey Trust

Company3.

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31% of the company‟s stock and 79% of the voting shares is held by the Hershey Trust company

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 WWY‟s management on the other hand is not too different from HSY‟s management structure

with the family of the late founder controlling a significant percentage of the firm‟s shareholding.

Global Market Share

WWY has continued to dominate the global market with double-digit growth in the Chinese and Indian

markets with a large population and opportunities for growth. 4 Conversely, HSY is yet to register a

significant presence in the global market at least compared to WWY as only about 11% of its global sales

are from outside the United States.

Management and Operating Structure

WWY maintains a lean leadership at the top echelon with an executive team consisting of only 6

members which is not too different from HSY with an 8-member executive team.

Mergers and Acquisitions

WWY has approached the market with intense aggressiveness buying world class brands such as Altoids,

Life Savers, Crème Savers and Sugus. In February 2007, the company acquired an 80% interest in A.

Korkunov5 marking its formal entrance into the Russian market.

On the other hand, HSY in October 2005, acquired Dagoba Organic Chocolates LLC based in Oregon and

in August 2005 completed the acquisition of Scharffen Berger Chocolate Maker, Inc and Joseph Schmidt

Confections, Inc6. By far, one of the most outstanding and profitable innovations pursued by HSY is the

existing production arrangement it has to manufacture and sell a couple of high premium brands such as

Nestle‟s Kit Kat and Cadbury Schweppes‟ Cadbury Caramello in the United States.

Competitive Landscape

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WWY controls 36% of the global gum market while Cadbury Schweppes trails with a 26% market share.
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A. Korkunov is the overall second player in the highly competitive premium-boxed chocolate segment of the
Russian chocolate market.
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Joseph Schmidt is a premium chocolate maker known for the production of artistic and innovative truffles and
colorful chocolate mosaics.

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The 2 firms are in a highly competitive industry with other multinational such as Nestle SA, Unilver Plc,

Kraft Foods, Inc and Cadbury Schweppes etc.

For instance, WWY met a challenge in the gum industry in the UK early 2007 where it has 98% market

share by Cadbury Schweppes with the introduction of the latter‟s highly successful Trident gum.

Strengths and Opportunities

WWY and HSY boasts of good brand names and flagship products which are synonymous with

high quality.

Emerging markets with large populations such as China and India provide new frontiers for

growth as the North American market saturates and flattens out.

Weaknesses and Threats

The confectionery industry faces a huge supply risk in terms of cocoa which is its main raw

material. West Africa accounts for about 70% of the world‟s crop of cocoa beans and any crisis in

that part of the world translates into volatile prices ultimately affecting the bottom line

significantly.

The ownership structure7 of WWY and HSY particularly with respect to the overriding influence

of the Trust companies makes the firm slightly inflexible to quickly react to changing market

conditions compared to other competitors with no overriding ownership control. (Please see

‘Ownership Composition’ in page 4-5).

Valuation and Recommendation

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The ownership structure is said to be responsible for the recent shake up and board room turmoil in HSY. The
Chief Executive Officer announced his resignation Oct 1 2007 while 8 of the company‟s independent board
members were forced to resign by the Trust company which has an overriding control over the business.

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Three valuation metrics (i.e. Discounted Free Cash Flow Valuation (DCF), Price to Book Value (P/B)

Valuation and Maintainable Earnings) were employed to arrive at a fair value for WWY and HSY.

General Assumptions Underlying the Valuation Method8

Assumed a projected annual growth rate of 8% and 2% for WWY and HSY respectively. HSY‟s

lower projected earnings rate is because of the present board room squabbles and the increased

risk it faces in the near to medium term as its market share in the United States which accounts

for almost 90% of total revenue continues to dwindle.

Assumed a 4% annual growth rate into perpetuity (i.e. terminal value computation) for WWY and

HSY.

Assumed an average industrial P/E ratio and P/B ratio of 21 and 8.5 respectively. (Source:

Morning Star Valuation Indices and MSN Money Central indices).

As a result of the obviously low average P/B ratio and realizing that HSY has a far higher P/B

ratio and the widely accepted assumption of the relative accuracy of the DCF method, I attached

the following weights to each valuation method to obtain the weighted average price – 85% for

DCF, 10% for Maintainable earnings and 5% for Price/Book ratio.

Used the number of shares in issue as at 31 December 2006 which is 275.74 and 227.05M

Ordinary shares for WWY and HSY respectively.

The results of the valuation methods are presented on the table below. Taking the weighted average of all

the valuation methods, I arrived at a weighted average share price of 60.77 and 47.21 USD for WWY and

HSY respectively. Based on the closing market price of the stocks on 13 December 2007, it would seem

that WWY and HSY are undervalued looking at the DCF method while WWY is overvalued looking at

the weighted average price. However, a closer look at the financials will reveal that HSY has greater

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Please see Appendix V – VIII for further details.

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potentials for growth assuming that WWY faces the same risk in terms of board room control vis-à-vis

the Trust companies.

As a result of the foregoing, a „BUY‟ proposition for HSY is recommended because it is trading below its

intrinsic value; provides opportunities for capital gain and high profit margins, while existing

shareholders „HOLD‟ the 2 stocks (i.e. WWY and HSY) rather than sell at this time.

WWY HSY
Discounted Free Cash Flow Valuation 65.22 48.93
Maintainable Earnings 40.32 51.71
Price to Book 73.62 25.59

Weighted Average 63.15 48.04

Current Share Price 61.06 38.66

Future Outlook

Economy

The American economy by its nature of resilience will still bounce back but clearly the future of

this industry is in making forays abroad and building new business relationships as Coca Cola

has done in the past decade in several countries. Untapped markets in the Far East, mid-

continental Asia and Africa present amazing potentials for future growth. The continued fall in

the value of the dollar makes critical imports such as cocoa more expensive invariably leading to

higher costs which can be partly or fully passed on to consumers because of the nature of

demand of the commodity but above all, the companies with significant foreign operations such

as WWY are bound to reap huge returns from the current exchange rate situation.

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WWY

WWY would need to figure out to improve its earnings yield in the medium to long term. It is envisaged

that the rapid expansion currently being pursued in China and other parts of Asia would continue as the

firm intends to use the returns on those investments to improve its bottom line and diversify its earnings

base.

HSY

There are clear indications that HSY may require a tune up in its balance sheet. The company may need to

consider some new capital injection or reduce its dividend pay out which is unlikely to shore up its capital

base particularly with meeting its working capital requirement.

Conclusion

The future of the two companies look bright and more particularly in the case of HSY in spite of the

recent board room wrangling. However, survival in the future will depend on the resilience of the

company as competitors realize the huge amount of potential which the industry possesses. Indeed, the

future will be marked by emphasis on accelerating core brand growth, investing in innovative new

products and disciplined global expansion marked by growing market share.

To the discerning investor, firms such as these two in the confectioneries industry provide some great deal

of hedge in the face of dwindling domestic consumer demand and falling value of the US Dollar.

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References

Fridson, Martin S. (2000). How To Be A Billionaire “Proven Strategies From The Titans of Wealth” John

Wiley & Sons Inc.

Hagstrom, Robert G. (1995). The Warren Buffett Way “Investment Strategies of the World‟s Greatest

Investor” John Wiley & Sons Inc.

Mary Buffett and David Clark. (2002). The New Buffettology “ The Proven Techniques for Investing

Successfully in Changing Markets That Have Made Warren Buffett the World‟s Most Famous Investor”

Rawson Associates

A number of general investment research sites were referenced and they include:

Yahoo Finance

Reuters

Standard and Poor‟s

MSN Money Finance

Morningstar

Motley Fool

www.wrigley.com

www.hersheys.com

www.cadbury.com

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