Tootsie Roll ready to rise

One stock that I have been following for a while now is Tootsie Roll Industries. Everyone knows this company. Who has not unwrapped the distinctive brown and white wrapper to unveil that nice chewy chocolate treat? Did you know that this company is also behind such favorites as Sugar Daddy, Sugar Babies, Tootsie Pops, Andes Mints (all of the above are Trademarked names), as well as many other treats? Tootsie Roll racked up sales of $493 million in 2007 selling these delicious, sugary treats. So, why the stagnation in the stock price? Most of the trouble comes from the quick rise in commodity prices over the past few years. The prices for refined corn products such as corn syrup have been higher as a large amount of corn and corn refining capacity has been redirected to ethanol production. Sugar, milk, and vegetable oil, all major inputs, have also seen prices rise. Although TR has been able to raise prices on their products when possible, they have not been in step with input costs and therefore, margins have suffered. Just a note, when advisable, TR does implement a hedging program to hedge their commodity input prices.
So, what do I like about Tootsie Roll? First of all, even though profit margins have decreased from 2005 through 2007, the company still enjoys double digit margins. In fact, profit margins for TR are higher than those of two of its closest competitors, Hershey (HSY) and Wm. Wrigley (WWY). Looking at the 5 year average ending 2007 profit margins, TR stands at 14.7%, HSY at 11%, and WWY at 13.2%. In fact, TR had nearly double the profit margin of HSY for year ending 2007.
Second, this company is virtually debt free. Beside $7.5 million in an Industrial Development Bond, this company has no LT debt. This puts TR in the position of being able to lever up its Balance Sheet and use the debt to invest in expanding operations overseas and growing its brand name.
Third, the company is still being run by Melvin and Ellen Gordon. Melvin has been Chairman since 1962. The company is run conservatively, consistently investing its capital and consistently paying both a cash and stock dividend. There is no excess with management and no frivolous use of shareholder money. Also, management owns 48% of the company so they have high level of vested interest in running a great company that looks to maximize shareholder value.
Having modeled a Discounted Cash Flow analysis of Tootsie Roll, I have calculated a fair value of $31.35 per share. This uses a conservative overall sales growth rate of 3.35%, and a Terminal growth rate of 3%. The cash flows are discounted by the firms weighted average cost of capital (WACC), which I have calculated to be 8.428%.
If corn, soybean oil, energy, and other input prices retreat in the near future, Tootsie Roll will be situated well in their industry.
Tootsie Roll currently trades at $26.25 per share, about 17% from my calculated fair value. I would look to buy this stock on any $2-$3 pull back and enjoy the cash and stock dividend and strong management team.