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DRIP PORTFOLIO

<THE DRIP PORTFOLIO>
Wrigley: Spitting Out Value? Part II
Examining earnings quality

By Brian Graney (TMF Panic)

ALEXANDRIA, VA (September 2, 1999) -- Yesterday, we took a look at Wrigley's (NYSE: WWY) return on invested capital (ROIC) figures for the past five years. After noting that ROIC declined steadily from 28.5% in 1994 to 23.6% in 1998, we put on our analytical jester caps and made a judgment call regarding this trend: It's not good. No sir, we don't like it one bit. Ideally, we want to invest our money in a company that is able to at least maintain and preferably expand this ratio over time.

So are we tossing this piece of gum into the nearest trash can? Nope.

ROIC at Wrigley has been slipping for a reason. The company is building plants all over the world, which boosts the denominator of our ROIC equation (total assets minus non-interest-bearing current liabilities minus excess cash) at a much greater rate than the numerator (net operating profits after tax, or NOPAT). Over the last five years, total invested capital has increased 69% to $1.3 billion. A large chunk of that increase is due to an 80% rise in net property, plant, and equipment over the same span.

In 1994, there were 12 Wrigley factories throughout the world spitting out packs of gum like minty-flavored Gatling guns. Over the past five years, three new plants have sprung up in such exotic locales as Poznan, Poland; St. Petersburg, Russia; and Bangalore, India. We can roughly measure the return Wrigley is receiving from its expansion efforts by looking at return on marginal invested capital (ROMC), which is a corollary of ROIC.

ROMC measures how much in marginal (extra) earnings are generated from every marginal (again, extra) dollar invested in the business. To see this relationship more clearly, we can compare invested capital (IC) per share and NOPAT per share with one another and get a feel for how well the company is deploying its new capital.

Here's what these two elements look like for Wrigley over the past five years:

                1994    1995    1996    1997    1998

IC/Share ($)    6.21    7.31    7.99    8.69   10.25 
% change               17.7%    9.3%    8.8%   17.9% 
Diff.  ($)              1.10    0.68    0.70    1.56

NOPAT/Share     1.77    1.97    2.13    2.23    2.42
% change               11.3%    8.1%    4.7%    8.5%
Diff.                   0.20    0.16    0.10    0.19

ROMC                   18.2%   23.5%   14.3%   12.2%

As the chart shows, invested capital per share rose by $1.56 between 1997 and 1998 to $10.25. Meanwhile, NOPAT per share increased $0.19 to $2.42 over the same period. Dividing $0.19 by $1.56 gives us ROMC of 12.2% for last year. Using per share amounts is a fair way of judging things in this case since Wrigley's diluted sharecount has barely budged in the past five years, which means NOPAT per share is not being warped by stock buybacks.

(As an aside, Jeff and I are torn over the question of whether the stable sharecount is a positive or a negative. Jeff would like Wrigley to step on the share repurchase gas pedal, while I think the company has demonstrated that it can return substantial value to its shareholders without buying back shares. If this issue continues to be a sticking point throughout our analysis, we'll settle our differences in the usual fashion -- by arm wrestling.)

Averaging ROMC over the past four years, we can see that Wrigley has been able to typically generate a 17% return from every new piece of incremental capital invested in the business. While that average is lower than ROIC, it's still beating the company's cost of capital of 11%. Moreover, investors must keep in mind that the bulk of the invested capital increase lately is due to the new plants, which are probably not operating at peak efficiency right away. Another point to keep in mind is that the economies in Eastern Europe and the Indian subcontinent, where the new plants are located, have not exactly been performing like gangbusters.

So from our perspective, Wrigley is making the right choice by investing its new capital in new plants and we're happy with the return it is generating. While many folks may be concerned that the company's net earnings have only been rising at a compounded annual rate of 6% over the past five years, looking at ROIC and ROMC shows that the quality of those earnings is very high. And as the Ford Motor Co. (NYSE: F) put it so well, "Quality is Job 1." Jeff will continue our analysis of this valuation sticky wicket tomorrow.

Drip Portfolio

9/2/99 Closing Numbers
Ticker Company Dly Pr Chg Price
CPBCAMPBELL SOUP-11/16$43.56
INTCINTEL CORP7/8$85.31
JNJJOHNSON & JOHNSON-1 1/2$100.00
MELMELLON BANK CORP-9/16$33.50

  Day Week Month Year
To Date
Since
7/28/97
Annualized
DRiP .15% -.49% 1.04% 18.41% 34.67% 15.23%
S&P 500 -.90% -2.16% -.10% 7.31% 40.51% 17.58%
S&P 500(DA) -.88% -2.12% -.10% 7.78% 43.14% 18.62%
S&P 500(DCA) n/a n/a n/a n/a 21.30% 9.63%
NASDAQ -.60% -.89% -.19% 24.70% 74.20% 30.25%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
9/8/9721.0659INTC42.573$85.31100.39%
11/14/9710.16JNJ78.233$100.0027.82%
11/5/9822.4534MEL34.156$33.50-1.92%
4/13/988.174CPB54.586$43.56-20.19%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
9/8/9721.0659INTC$896.84$1,797.19$900.35
11/14/9710.16JNJ$794.85$1,016.00$221.15
11/5/9822.4534MEL$766.91$752.19($14.72)
4/13/988.174CPB$446.18$356.08($90.10)
  Cash: $24.33  
  Total: $3,945.78  


Key
• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Note
Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.





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