In our never-ending quest to understand The Wm. Wrigley Jr. Co. (NYSE: WWY), today we'll take a peek at the Chicago gum king's fourth-quarter and full-year 1999 results.
After a bumpy start to the year, the company ended up spitting out overall year-over-year sales growth of 3% and net earnings growth of 4%, excluding a one-time gain from a property sale last year. Those rates of growth are not going to set any land-speed records, but they are more or less consistent with the numbers that the business has put up over the past few years as the international economy has swung around like Tarzan on a jungle vine.
However, the outlook for higher short-term growth appears to be brighter than it was a year ago. Springboarding the company into the new year was an 8% rise in Q4 sales, the highest growth rate for the final quarter in the past three years. Unfortunately, a higher tax bite prevented much of that revenue growth from translating into higher profits, which rose by only 4% during the period. Still, an 11% jump in quarterly U.S. sales was a nice way to end the year and raises our hopes that a higher level of earnings growth may be in store for 2000.
The future level of earnings growth is always a big-time concern for investors, regardless of whether the company in question is a well-established leader in a relatively static industry like gum or a whiz-kid upstart in a fast-changing, emerging business like broadband networking. As any darned Fool can tell you, earnings growth is what really matters in the long run. It's practically a universal truth that the firms that can successfully grow their earnings the fastest will end up fetching the highest multiples and are worth the most in the marketplace.
Right?
(Uh, oh. Hear that sound? That's the noise of a Wise myth about to fall down.)
We dug out the following nugget of insight from a dusty, old, forgotten 1994 issue of Outstanding Investor Digest that was buried under some cobwebs and a heap of Chalupa wrappers in the bowels of the Fool HQ library. Hopefully, the folks at OID won't mind too much if we share it here. It came from an investor named Warren Buffett, who happens to run a company by the name of Berkshire Hathaway (perhaps you have heard of him):
"We're willing to buy companies that aren't going to grow at all -- assuming we get enough for our money when we do it.... If you were to put $1 million in a savings account, would you rather have one that paid you 10% a year and never changed or one that paid you 2% a year and increased 10% a year? You can work out the math."
What Buffett is referring to here is the idea of selecting high-returning businesses, not just high-growth businesses. He continues:
"But you can certainly have a situation where there's absolutely no growth in a business and it's a much better investment than some company that's going to grow at very substantial rates -- particularly if they're going to need capital in order to grow.... And generally, financial analysts don't apply adequate weight to the difference between those."
This second part alludes to the desirability of companies where much more cash is regularly flowing out of the business than is flowing in. Both parts of the above quote are interesting in their own right and carry a great deal of relevancy in the case of a company like Wrigley
Even though its returns have been falling in the past few years (which is our main cause of concern from an investing perspective, by the way), Wrigley still boasts an enviable return on invested capital. By our calculations, the firm's annual ROIC is in the 23% to 24% range, easily above its estimated all-equity cost of capital of 11% and Drip Port's own required return on investor capital of 15.5%. Additionally, it's above the mean 12.5% ROIC of the S&P 500 in 1998, according to numbers crunched by analyst Michael Mauboussin and his colleagues at Credit Suisse First Boston. So, the high-return shoe seems to fit.
Further, Wrigley has a well-established capital efficiency track record. We'll have to wait until the year-end financial report is filed with the SEC to see exactly how much money was chewed up in capital expenditures in 1999, but we have a pretty good idea that the figure was not unusually large. Wrigley has a knack of investing roughly half of its annual earnings back into the business every year to keep things going and expand into new markets while paying the remaining half out to shareholders in the form of dividends.
Interestingly, since 75% of the firm's shareholders (Note: that's different from 75% of all shares) participate in the Drip plan, a fairly decent chunk of those dividends immediately head right back into company's coffers as Drippers buy more shares. So, Wrigley's business is pretty much a self-supporting cash generator that doesn't need to raise any capital at all in order to grow. Think of it as a corporate Chia Pet, only with less-annoying TV commercials.
Given the wide moat around the firm's gum business, we feel pretty confident that Wrigley's cash flows will be higher 10 years from now than they were this year. We don't see the industry changing too much in the next decade, nor do we see demand for gum slackening off for some unknown reason or some upstart charging in and stealing a portion of Wrigley's estimated 50% share of the global market. And even if we are dead wrong and there is zero earnings growth over the next decade, the company still might represent a pretty compelling investment possibility from our vantage point. We'll try to examine that scenario in more detail and other aspects of the Wrigley investment case in future columns.
