One of the most reliable ways to outperform the stock market is to own dominant businesses with disposable products in slow-changing industries. The advantage of selling disposable products is that consumers constantly need to repurchase the product. The advantage of slow-changing industries is that there is less risk of competitors deploying disruptive technologies that displace the dominant businesses. Consequently, leading businesses are able to leverage their positions to grow earnings for almost endless profits for long-term shareholders.
Wrigley is in the gum and confectionary business, and owns well-known brands such as Doublemint, Juicy Fruit, Big Red, Excel, Extra, Life Savers, and Altoids. Gum is obviously a disposable product (as anyone who has ever reached under a desk at the public library knows), and Buffett described the industry best when he said that he "doesn't think the Internet is going to change how people are going to chew gum." Wrigley has been dominant for decades in a slow-changing industry, and it's easy to believe that it'll still be dominant in 50 years.
Gum has an advantage in that it's less of a "sin" product than soft drinks and beer. While soft drinks can lead to obesity and beer can lead to alcoholism and impaired judgment, chewing gum has many positive side effects. Gum can help prevent tooth decay, whiten your smile, and treat bad breath, leading to potential romantic encounters (to be fair, beer has also led to the occasional romantic encounter). Because of these positives, gum is less likely to be impacted by fad diets (Atkins) or social restrictions (Prohibition).
The benefits of dominating such a great market are evident in Wrigley's financials. The company is almost debt-free and has $650 million in cash, more than $500 million of free cash flow, net margins approaching 14%, and a solid 25% return on equity. These are great numbers for almost any business.
With more than 40% of the global gum market, Wrigley is a dominant worldwide player. Cadbury Schweppes (NYSE: CSG ) , with brands such as Dentyne, Trident, and Certs, is Wrigley's primary competitor. Cadbury has about 28% of the global market. Second-tier competitors include Hershey Foods (NYSE: HSY ) , with brands including Breath Savers, Ice Breakers, and Bubble Yum, and Topps (Nasdaq: TOPP ) with Bazooka Joe.
Wrigley is strongest geographically in the $2.2 billion U.S. gum market, where it has about 60% market share. Cadbury, on the other hand, is stronger in Europe and South America. Most of the industry's growth, however, is in the developing Southeast Asia market. While the United States consumes 160 pieces of gum per capita, China consumes 10 pieces, and India consumes just two. Wrigley is already well positioned in the region and has factories in China, Taiwan, and the Philippines. In fact, after the United States, China is Wrigley's second largest market -- Wrigley has a 50% market share in China, more than triple the next 10 companies combined.
The risk where Wrigley is already established is minimal. That is, after all, why I love the company. It would take decades to displace Wrigley in the United States.
I see Asia as its greatest risk. If the Asian gum market does not continue its anticipated growth, or if there is a backlash against Western influences such as gum, or should Wrigley simply fail to execute in Asia, it would significantly impact the company's growth. If Asia falters, the downside is that Wrigley could approach the saturation point in other world markets. So without Asia, it may have difficulties growing faster than GDP.
A second risk is on the pensions side. Right now, Wrigley's pensions are underfunded by about $100 million. Plus, Wrigley's anticipated long-term rate of return on pension plan assets is 8.5%, a relatively high number, particularly with interest rates so low. I'd prefer to see more conservative assumptions along the lines of a 7% anticipated rate of return. Consequently, I think there's a chance that, at some point in the future, Wrigley will take an earnings hit from re-evaluating its pension assumptions and covering its pension liabilities. Regardless, we're talking about a company that earned $500 million last year, with total pension obligations of $650 million. The pension issue may wipe out a quarter or two of earnings, but it won't threaten the company.
The Foolish bottom line
Wrigley is one of the best companies in the world, and one that I'd love to own. So ... why don't I own shares? Because everyone knows that it's an excellent company, so the stock is almost always expensive. Even taking relatively optimistic assumptions, such as a 9% discount rate, 10% growth for the next 10 years, and 4% growth thereafter, the Motley Fool Inside Valueintrinsic value calculator shows that the stock is worth about $70, roughly its current price. I buy stocks that have a large margin of safety with conservative assumptions, not stocks that have no margin of safety with optimistic assumptions. So, until the price improves, Wrigley will remain a stock I'd love to own.
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Richard Gibbons, a member of theInside Valueteam, occasionally chews gum, but does not own shares of any companies mentioned in this article. Coca-Cola and Anheuser-Busch are Motley Fool Inside Value recommendations. The Motley Fool has adisclosure policy.