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Wrigley’s Gum Outlasts Challenges

by Andrea Bartz
Oct 23, 2007

Wm. Wrigley Jr. Co.’s abandoned 19th-century plant sprawls across Chicago’s South Side like an old, dying giant. The hodge-podge of multi-storied, interconnected buildings closed its doors permanently at the end of 2006.

But just a few miles north, in a sleek building on Goose Island, workers in lab coats pour beakers of ingredients into kneading devices in pursuit of America’s newest favorite gum. Employees at Wrigley’s Global Innovation Center, which opened in 2005, work to enhance current products like Extra, Winterfresh and Orbit, and to develop new goodies and packaging.

Despite losing U.S. market share to Cadbury Schweppes PLC and a recent rise in its famously low prices, Wrigley has shown investors it’s not growing stale. Nearly all the analysts who cover the company agree that even at $66 a share, reflecting a high price-earnings ratio of 31, this long-time favorite stock is still a good investment.  Five analysts rate it "buy" or "outperform," while 10 call it “neutral”, “peer perform” or "hold." One rates it "underperform."

“A slowly improving domestic business and continued international prosperity paint a bright long-term picture,” Morningstar analyst Mitchell Corwin wrote in a recent report.

Wm. Wrigley Jr. Co. sells gum (still including Doublemint and Spearmint), mints and other confections in more than 180 countries. In 2005 Wrigley acquired Kraft Foods’ confectionary brands including Altoids and Life Savers. But the $1.5 billion purchase backfired. Corwin calls it “a significant miscalculation.”

“They underestimated the general weakness of the brands,” he said in a telephone interview. “The brands had been heavily promoted but underinvested in” by Kraft. Kraft “propped up sales” by running promotions (like buy-one-get-one-free deals), but didn’t invest in the long-term promotion the brands would need for staying power: heavy advertising, continued innovation and periodic product enhancements, according to Corwin.

When Wrigley took over and removed the quick-fix promotions, the Altoids and Lifesavers brands’ weaknesses were revealed, so since then Wrigley has been working to revive their images, Corwin continued.

Wrigley’s net income for 2006 was $529.4 million, or $2.24 per share, up 2 percent from 2005 – a tiny gain that Wrigley anticipated shortly after its ill-fated Kraft acquisition. In its annual meeting the company reminded shareholders that about half of its 2006 2-percentage-point gross margin decline was due to the costly Lifesavers and Altoids acquisitions.

But recent income statements look less bleak: net income for the quarter ended June 30 was $169.8 million, up 21 percent from last year’s period.

Analysts' consensus estimate for 2007 profit is $620 million, up from $529 million last year.

So what of Wrigley’s high price-earnings ratio, the recent price increase and the shrinking market share? Analysts say the real story behind the numbers is rosier than one might think.

“The firm is taking positive steps to revive the purchased brands and cement its U.S. leadership position in chewing gum,” Corwin wrote in a report.

With a P/E far above the S&P 500 stocks’ 18 average, Wrigley’s stock may appear bloated. But the food industry’s higher margins, coupled with Wrigley’s strong growth profile, are keeping the ratio high, Corwin said.

“Consumer product companies have strong margins and predictable cash flows, so a lot of them trade above market value,” he stated. But beyond that, “Wrigley has a presence in a lot of emerging markets, so there’s a lot of room for them to grow.”

This year Wrigley acquired an 80 percent interest in A. Korkunov, a privately held premium chocolate company in Russia, with plans to acquire the remaining 20 percent over the next few years. The acquisition enables Wrigley to enter the Russian chocolate market via a recognizable brand.

The company also is broadening marketing efforts abroad. In August it hired DDB Worldwide as an additional global creative advertising agency, joining Chicago-based BBDO Worldwide, consolidating work done previously by several agencies across the globe.

Wrigley upped U.S. gum prices this year by about 10 percent, or a dime a pack, to make up for inflation, recover higher input costs and provide funds for additional investments in marketing and research and development, a Wrigley spokesperson said. The increase began in May and was fully in effect Oct. 1.

Though Wrigley’s third-quarter results are not available, a report by Neilsen Financial Services, provided by J.P. Morgan Securities Inc., found that the company's dollar sales rose 7 percent in the 12 weeks ended Sept. 8, compared with a year earlier, while unit sales fell 1.8 percent. But a J.P. Morgan analyst isn’t worried. The price increase “should beef up gross margins in 2007,” Pablo E. Zuanic wrote in a recent research report. “While management said that there could be some impact on volumes, we believe that they must feel very comfortable about their innovation pipeline and the competitive environment.”

And what of Wrigley’s deteriorating U.S. gum market share vis-à-vis Cadbury? Wrigley’s share has dropped from 67.9 percent in early 2005 to less than 59.5 percent in August 2007, while Cadbury’s share has climbed to 35 percent, according to J.P. Morgan.

The implication of this data is a call for action on Wrigley’s part: “Competitive intensity from Cadbury suggests a higher cost of doing business going forward, and Wrigley needs to show it is up for the task,” Credit Suisse analyst Robert Moskow wrote in an Oct. 8 report.

But most analysts say it’s unlikely that David will topple Goliath, provided Wrigley actively strives to maintain its historical hold over the market.

“Wrigley is hemorrhaging shares in the U.S.,” Corwin said. “Going forward, they’re not going to continue to stand idly by while Cadbury takes market shares away from them.”

Case in point: This summer, Wrigley launched a new brand called 5 in response to Cadbury’s trendy Stride chewing gum. The 5 brand is “the first innovation in the sugar-free stick gum category in 10 years,” Zuanic noted in his report. The teen-targeted gum is the first to pop out of Wrigley’s state-of-the-art Chicago research lab.

What’s more, analysts say, Cadbury is a long way from nipping at Wrigley’s heels. The company, which entered the U.S. gum market in 2003, faces major corporate restructuring through 2008. While splitting Americas Beverage into two businesses, Cadbury may be too busy to focus on investing in new markets.

“We see potential restructuring changes at Cadbury as a source of distraction for Wrigley’s major competitor,” Zuanic wrote.

Furthermore, the real driver behind Wrigley’s long-term predicted success lies internationally, where the company obtains about 60 percent of total sales, Corwin says.