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Graduate Student Security Analyses Paper

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

(HSY)

Investments

December 2007

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 wellloved 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,
1

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

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 USD

5,000,000.00 4,000,000.00 3,000,000.00 Total Revenue 2,000,000.00 1,000,000.00 2004 2005 Years
2006

Graph of WWY Revenue Stream in the last 3 years

Simple average used.

Total Revenue

Amounts in Thousands of USD

5,000,000.00 4,800,000.00 4,600,000.00 Total Revenue 4,400,000.00 4,200,000.00 4,000,000.00 2004

2005 Years 2006

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).

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

Market Capitalization WWY HSY CZZ TR IPSU Key CZZ HSY IPSU PARF. OB Revenue Growth WWY
RMCF HSY TR PARF.OB Long Term Growth Rate WWY HSY Revenue Growth WWY RMCF HSY TR
PARF. OB Dividend Yield HSY RMCF WWY TR IPSU Net Profit Margin RMCF TR WWY PARF.OB HSY
Total Revenue WWY HSY IPSU TR RMCF

Position 1 2 3 4 5

Cosan Limited CL A The Hershey Company Imperial Sugar Co Paradise Inc

RMCF TR WWY

Rocky Mt Chocolate Tootsie Roll Ind Wrigley WM Jr Company

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.

31% of the company‟s stock and 79% of the voting shares is held by the Hershey Trust company
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.
A. Korkunov is the overall second player in the highly competitive premium-boxed chocolate segment of
the Russian chocolate market. 6 Joseph Schmidt is a premium chocolate maker known for the production
of artistic and innovative truffles and colorful chocolate mosaics.

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.

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

Please see Appendix V – VIII for further details.

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.

Discounted Free Cash Flow Valuation Maintainable Earnings Price to Book

WWY 65.22 40.32 73.62

HSY 48.93 51.71 25.59

Weighted Average Current Share Price

63.15 61.06

48.04 38.66

Future Outlook
Economy The American economy by its nature of resilience will still bounce back but clearly the future of
thisindustry 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, midcontinental 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.

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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