CFA Institute Global Research Challenge 2014 - University of Scranton

CFA Institute Research Challenge hosted by

CFA Society Philadelphia

CFA INSTITUTE RESEARCH CHALLENGE 31 JAN 2014

Market Profile Market Cap $1.66 Billion Recent Price $87.69 52-week High

$97.80

52-week low $67.28 Shares Outstanding

18.8 million

Average Daily Volume

53,560

Institutional Holdings

66.3%

ROE 13.0% ROA 9.8% P/E 24.14 TEV/EBITDA 10.4x TEV/Sales 1.69x Source: Bloomberg, S&P Capital IQ

Figure 1: JJSF total returns vs. ^RUA & S5CONS

Source: S&P Capital IQ

Highlights

• We initiate coverage with a buy recommendation and a price

target of $106.00, or 21% above the recent trading price.

• JJSF is a defensive growth stock that can continue to grow faster

than the industry through both price and volume increases. A

strong balance sheet affords the company the ability to continue

making strategic acquisitions that can be successfully synergized into

existing operations and provide additional leverage.

• Targeting niche markets enables JJSF to consistently report operating metrics above its peers. By establishing a leading position in these categories, JJSF is able to combat the negative competitive forces in various markets and position itself for sustained above average growth and profitability.

• Proven management that is shareholder friendly. Since initiating a dividend policy 2005, JJSF has increased its annual dividend at a compound annual growth rate (CAGR) of 19.9%. JJSF recently announced a doubling of its dividend for 2014, but our estimated payout ratio still has JJSF remaining in the lower 90th decile in this category. Strong cash flow generation and balance sheet suggest continued annual increases in the dividend are likely.

Important disclosures appear at the end of this report

J & J Snack Foods Corp. Ticker: JJSF GICS Recommendation: BUY Estimated Upside Exchange: NASDAQ Sector: Consumer Staples Target Price $106.00 20.88%

Industry: Food, Beverage, & Tobacco Price as of

Sub-industry: Packaged Foods and Meat products Jan. 29, 2014: $87.69

FCFF sensitivity analysis

EBIT growth rate (%) 7 8 8.5 9 9.3 9.5 10 11 12.5

5 $86.53 $88.83 $89.99 $91.17 $91.89 $92.36 $93.57 $96.02 $99.78

10 $93.15 $98.50 $101.29 $104.15 $105.91 $107.09 $110.12 $116.42 $126.54

High growth period (years)

-‐100

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Ret

urn

(%)!

JJSF!

Russell 3000 Index!

S&P 500 Consumer Staples Index!

Figure 2: Shareholder Structure

Source: Bloomberg

Figure 3: Revenue by Product

Source: Company Data

Figure 4: Facility Locations

Business Description

JJSF manufactures nutritional snack foods and distributes frozen beverages that it markets nationally to the food service and retail supermarket industries1. JJSF targets niche categories where it can be one of the preeminent players and has with operations in the United States, Canada and Mexico. Headquartered in Pennsauken, New Jersey, JJSF was established in 1971 by Gerald B. Shreiber when he acquired the assets of J&J Pretzel Co. at auction for $72,100. Shreiber, who is currently the CEO, Chairman of the Board, and President, has grown a company that dealt solely in soft pretzels with $400,000 in sales to a publically traded snack food conglomerate with $867.7 million in sales in fiscal 2013. The whole is greater than the sum of its parts. JJSF has developed a diverse line of snack foods including soft pretzels, frozen beverages, and various other baked goods. They have three market segments: Food Service, Retail Supermarkets and Frozen Beverages. The Food Service segment consists of soft pretzels, frozen juice treats and desserts, churros, dough enrobed handheld products and baked goods including various cookie products. The Retail Supermarket segment is made up of frozen and prepackaged products that are purchased by consumers for consumption at home. Some of the products included in the Retail Supermarket segment are SuperPretzel Soft Pretzels, Luigi’s Real Italian Ice, Whole Fruit frozen fruit bars and sorbet, ICEE Squeeze-Up Tubes, and Patio burritos. The Frozen Beverage segment sells frozen beverages such as ICEE and Slush Puppie to the food service industry. The company is focused on developing new and innovative products, further penetrating into existing market channels, and expanding established products into new markets. Experienced management with a history of excellent execution Though the board and management team have seen some changes over the years, the core culture and principles remain in place that have enabled JJSF to report its 42nd consecutive year of record sales and profitability this past fiscal year. Other members of management include CFO Dennis G. Moore, who has held this title in addition to other roles since June of 1992, and Robert M. Radano, who has been the COO since May 1996. Moore and Radano joined JJSF in 1984 and 1972 respectively, displaying management’s commitment in the success and longevity in the company. Other members of the BOD bring valuable experience to JJSF in freight transportation, warehousing, third party logistics, marketing, manufacturing, commercial and investing banking, and frozen beverages.

1 J & J Snack Foods 2013 10K

36%

30%

5%

20%

9%

29%

Institutional!Institutional Mutual Fund!Mutual Fund!Insider!Retail!

21%!

11%!

7%!

6%!32%!

15%!

8%!

Soft Pretzels! Frozen Desserts & Treats!Churros! Handheld!Bakery Products! Frozen Beverages!Other!

Figure 5: Porter’s 5 Forces Analysis

Figure 6: Peer Group and Sub-industry Capital Structures



Industry Overview and Competitive Positioning

Rivalry in the packaged food and meats industry is strong. Product differentiation tends to be more perceived than actual – this is why some companies spend so much on marketing in an attempt to convince customers that their products truly are “one of a kind.” Switching costs between brands within the category are also very low. Moreover, most firms tend to incur significant fixed costs due to factory expenses and storage costs, the later of which tend to arise because of the perishable nature of their products. The threat of substitute products is extremely high. Convenience plays a large role because packaged snack foods are widely available and consumers are likely to choose a product based on location and accessibility. Price also plays a large role, and consumers are more likely to choose the lowest price option when it comes to snack foods.

This high threat of substitutes means that JJSF’s strategy of achieving leadership in niche categories has the potential to end up being less profitable as one might initially expect. JJSF’s is not just competing with other firms that make similar products (e.g Snyder’s-Lance, Inc. [NasdaqGS:LNCE]), but rather a whole host of snack food companies like The Hershey Company (NYSE:HSY), Diamond Foods, Inc. (NasdaqGS:DMND), Unilever plc (NYSE:UL), and ConAgra Foods, Inc. (NYSE:CQB)2. Moreover, Mr. Shreiber has commented previously that for certain products he considers his primary rival to be smaller, regional players – something that certainly makes sense when you consider regional bakeries and the fact that JJSF’s largest product segment is still bakery goods, not pretzels (appendix 11).

The bargaining power of suppliers in the packaged food and meats industry is weak. There are many suppliers of the raw materials that JJSF and other corporations’ use as their inputs, and because of this they tend to be competitively priced. The biggest source of supplier power comes in the form of switching costs, which may be significant depending on how complex and intergraded the relationship is. Buyer power strength depends on who you consider to be the “buyer.” End consumers are extremely fragmented and have little power; however, the ones who actually decide whether or not to sell JJSF’s products (retailers, fast food chains, etc.) are far fewer in number and wield significant power.

Health and nutrition have become key drivers for the industry In a recent survey Deloitte and Touche LLP found that 79% of executives believed that nutrition was the main driver of the packaged food industry3. JJSF has witnessed the push toward healthier products first hand. Since losing contracts with schools around the nation, JJSF has formulated new recipes to make their snacks healthier. The lack of nutritional value has not impacted sales as greatly as earlier anticipated, but JJSF has reformed their recipes to cater to America’s issue with obesity. In the most recent quarterly earnings call, Gerry Shreiber, the CEO, mentioned that JJSF has started to sell their products in schools again.

2 This, along with JJSF’s unique business model is why we decided to ultimately focus on comparing the company to peer group statistics. 3 Deloitte and Touche LLP - Food and Beverage 2012: A Taste of Things to Come

0

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Threat of New

Entrants

Bargaining Power

of Suppliers

Bargaining Power of Buyers

Rivalry in the

Industry

Threat of SubsGtute Products

Debt!43%!Equity!

57%!

Peer Group!

1% 9%

4% 3%

1%

11%

9%

4% 2% 3% 11%

15%

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Figure 8: Sub-indusrty debt ratings! AA!

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A!

BBB+!

BBB!

BBB-!

BB+!

BB!

BB-!

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B!

B-!

Debt!38%!Equity!

62%!

GICS Subindstury!

Impulse buys + deliberate purchases = strong sales growth Almost everywhere you go it is possible to find one of JJSF’s products ( see figure 12). This convenience factor enables JJSF to capitalize on “impulse buys” in additional to deliberate purchases. This also helps create familiarity with JJSF’s numerous brands and potentially engender consumer loyalty.

Figure 9: Revenue growth sensitivity to GDP

Source: The Federal Reserve, S & P Capital IQ

Figure 10: Returning Capital to Shareholders

Source: S&P Capital IQ, Team calculations & forecasts

Figure 11: Peer group cash and marketable securities

Investment Summary Attractive Valuation and Strong Fundamentals Our intrinsic value estimate is derived from historical operational performance and what we consider to be reasonable estimates with an eye towards conservatism in order to embed a margin of safety in our estimates. Using trailing twelve-month data we value the stock at $106 per share, or 21% above the recent share price of $87.69.

Outstanding Operating Performance Since going public, JJSF has been able to consistently deliver impressive operational metrics and outperform most peers in terms of growth and profitability. This has been achieved primarily through its strategic initiative of focusing on niche product categories where it can be a category leader. Due to the current management team, market opportunities, and category positioning, we believe these trends are likely to continue.

Sound Financial Position JJSF currently has over $215 million in cash and marketable securities (the vast majority of which are available for sale), or $11.54 per share – $5.66 of which is cash and cash equivalents. This accounts for over 32% of total assets, which is the second highest percentage among our peer group. Although this is currently hurting operational performance measures and overall growth, when combined with its strong cash flow generation, this provides the firm with ample cash to deploy when attractive investment opportunities present themselves in addition to continuing to return cash to shareholders.

Bucking the trend Research has found that most firms only destroy shareholder wealth through acquisitions4. But as both its historical operational performance metrics and stock price performance can attest to, JJSF has done an excellent job of not falling trap to overpaying for growth. Cumulative gains on bargain purchases are actually larger than impairment charges – $6.6 million vs. $1.2 million. Management is steadfast in its commitment to waiting until an attractive opportunity presents itself before pulling the trigger, thereby enabling the firm to continue to have an ROIC well above the peer group median.

Shareholder Friendly Management Since initiating a dividend in fiscal 2005, JJSF has increased its dividend each year at a CAGR of almost 20% (12.5% if you exclude the recent doubling of the dividend this past November). This means that anyone who purchased the stock prior to the end of July in 2009 has a current yield of 3% on shares of a company that has consistently grown faster than the industry and. This has resulted in impressive total returns for investors who have reinvested their dividends see figures 1 and 12. Of the 31 companies in JJSF’s peer group that currently pay a dividend, JJSF is currently tied for 28th place with a yield of 1.5% and our forecasted 2014 payout ratio is well below the peer group median. We believe continued annual increases are very likely.

4 Moeller, Schlingemann, & Stulz (2003) found that in a sample of 12,023 acquisitions shareholders of these firms lost a total of $218 billion when acquisitions were announced. A KPMG study (1999) found that this underperformance tends to persist over time.

-‐5.00% 0.00% 5.00% 10.00% 15.00% 20.00%

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Percent Change in GDP!

Percent Change in Revenue!

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Dividends per Share!

Payout Ratio!

12.5% CAGR!

Figure 12: Settings where JJSF products can be found • Business Dining • Military • Club Stores • Movie Theatres • Colleges & Universities • National Restaurant Chains • Convenience Stores • Regional Restaurant Chains • Healthcare • Schools K-12 • Independent Restaurants • Sports & Entertainment • In Store Bakery • Supermarket & Grocery • Mass Merchants • Theme & Amusement Parks Source: J&J Snack foods

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Cash & Marketable Securities/Total Assets!Cash and Marketable Securites per Share!

JJSF


Figure 13: JJSF stock price and key acquisitions from 2004 to today

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ln Revenues !( USD mm)!

Figure 14: Modeling Revenues!

Predicted!

Actual!

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Jan-04! Jan-05! Jan-06! Jan-07! Jan-08! Jan-09! Jan-10! Jan-11! Jan-12! Jan-13! Jan-14!

Acquires assets of New York Pretzel!

Acquires assets of Kim & Scott's Gourmet Pretzels!

Acquires Frozen Handheld from ConAgra Foods!

Acquires Radar, Inc.!

Acquires Slush Puppie!

Acquires ICEE of Hawaii, Inc.!

Acquires SnackWorks LLC!

Acquires Country Home Bakers!

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Figure 15: Forecasting EBIT margin!

Revenue!

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Long-term margin forecast!


Figure 16: Valuation Summary USD mm

Present value of FCFF in high growth phase

384.30

Present value of terminal value

1,423.89

Value of operating assets

1,808.19

Value of Cash & Equivalents 215.41

Value of firm

2,023.60

Value debt

39.31

Market value of equity

1,984.29

Value of Equity in options

6.16

Value of Equity in common stock

1,978.13

Share price

$105.91

Source: Team Estimates

Figure 17: FCFF Inputs

Growth Period High Low

Growth rate

9.30% 2.75%

Adjust debt ratio

2% 24%

Beta

0.78 1

Risk-free rate

2.67% 2.67%

Equity risk premium 5.29% 5.29%

After-tax cost of debt

3.07% 3.26%

Tax rate

36% 35%

Adjusted ROC

18% 11%

Adjusted reinvestment rate 40% 25%

Source: Team Estimates

Figure 18: Cost of Debt

Source: Bloomberg, Team Estimates

DCF Valuation

• Model: We choose to use a FCFF model over a FCFE model because we believe that the likelihood of JJSF changing its capital structure in order to optimize its cost of capital by the end of its high growth phase is a far more reasonable assumption than the alternative, i.e. remaining debt free into perpetuity. JJSF currently has less debt, in the form of lease obligations, than all but one other peer group constituent. In an attempt to derive a more accurate estimate of JJSF’s intrinsic value the follow adjustments to the company’s GAAP metrics were made:

o Operating leases were capitalized to account for off balance sheet financing and added to the present value of capital leases to find the current present value of debt.

o Employee options were valued using the Black-Scholes model and the present value subtracted from the value of equity.

• Sales: JJSF’s small size and penchant for purchasing business that can easily be folded into its current operations has enabled it to consistently grow faster than the industry average. We anticipate that this will continue for at least ten years and will due to both volume and price increases.

• Margins: We are forecasting for continued EBIT margin expansion due to the operational leverage afforded by increasing production volume, albeit at a much slower rate than the historical average – only 77 basis points to 12% by the end of our high growth period. Though above the industry median, our belief is that JJSF leadership positioning in niche categories will enable it to achieve margins that are higher than those competing in the more competitive segments of the GICS sub-industry. This results in EBIT growing at a CAGR of 9.3% during our high growth period.

• WACC: The cost of equity was found using the CAPM model. An equity risk premium was calculated by using a two-stage dividend discount model to discount the forecasted dividends and buybacks on the S&P 500 and set the current value of the index equal to its intrinsic value. The implied equity risk premium was used in favor of a historical approach as research has shown that the current implied ERP has a higher correlation with future ERPs.5 The current yield on the 10-year US government bond was used as a proxy for the risk-free rate. A bottom-up beta was utilized to minimize the standard error of the estimate and was calculated using the peer average (corrected for cash) and JJSF’s current tax rate and leverage ratio (adjusted for leases)6. Given that JJSF currently has no publicly traded debt, estimating a pre-tax cost of debt was calculated by creating a synthetic rating and using the current corporate spread over the U.S. 10-year Treasury. We assigned JJSF with a S&P synthetic rating of BBB and added the current spread corporate spread of 1.54%.

5 Damodaran (2013) Equity Risk Premiums (ERP): Determinants, Estimation and Implications The 2013 Edition 6 Our estimated beta is actually the same as the Bloomberg 5-year regression beta using weekly data.

Risk Free Rate 2.67%

Synthetic Rating BBB

Spread 1.54%

Pre-tax cost of debt 4.21%

Figure 19: Return on Invested Capital Source: Company data, Team calculations Figure 20: Segment Revenues and Operating Margins

Source: Company data, Team calculations

• We assumed that metrics would revert towards peer median levels during the stable phase. Constituents for peer comparisons were selected using Value Line – all US based publicly traded firms in Value Line’s food processing industry were included in peer group calculations.

Multiples Analysis

Historically JJSF has traded at a TEV/EBITDA discount to both the GICS sub-industry and its peer group. We find this to be unwarranted due to its above average growth, lower leverage, and well above average returns on invested capital; and believe this lends additional support to our view that the stock is currently undervalued, and perhaps even a reason why the security is underpriced. Given that this runs contrary to an earnings yield comparison, we suspect that the market is currently focusing more on earnings than the underlying strength of the business in question – an unfavorable comparison for firms who have below average leverage.

Figure 22: TEV/EBITDA comparison


Figure 23: Earnings yield

Source: S&P Capital IQ, Team calculations

0%!

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JJSF! Peer Median!

GAAP TEV/EBITDA

CY2009 CY2010 CY 2011 CY 2012 Latest

JJSF 6.8x 7.8x 8.1x 8.6x 12.1x

GICS sub-industry 10.0x 9.5x 10.3x 11.1x 11.7x

Peer group 10.2x 14.9x 10.1x 11.5x 12.5x

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USD mm

Frozen Beverages! Retail Supermarket!

Food Service! Food Service OM!

Retail Supermarket OM! Frozen Beverages OM!

JJSF OM!

0%!2%!4%!6%!8%!

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JJSF! Peer median!

Source: S&P Capital IQ, Team calculations Figure 24: Return on Equity

Source: S&P Capital IQ, Team calculations

Figure 25: Cash Conversion Cycle

Source: Company Data, Team calculations

Financial Analysis

5-way DuPont Decomposition Analysis At first glance JJSF’s ROE doesn’t appear to be anything noteworthy as it has stayed relatively close to both the GICS sub-industry and peer group medians. However, after doing a 5 way DuPont Decomposition we were left quite impressed. This is because the only thing preventing JJSF from having a ROE that is far higher than the average for this industry is its lack of leverage. In fact, JJSF has asset turnover, operating margin, and interest burden ratio have remained significantly above the peer group median since 2008 (JJSF’s tax burden has oscillated around the peer group median). Were the firm to readjust its capital structure in the near future so that it had leverage and interest burden ratios equal to the industry average JJSF’s ROE would rise north of 19% assuming it could invest its newly raised capital in equally profitable projects. (Please see appendix 10 for a charts of all the components of the DuPont decomposition).

Figure 26: DuPont Decomposition

Peer Median

JJSF Current

JJSF with Peer Median

Tax Burden 6.48% 63.88% 63.88% Interest Burden 90.95% 103.48% 90.95% Operating Margin

9.73% 11.23% 11.23%

Net Profit Margin

5.73% 7.42% 6.52%

Leverage Ratio 2.13 1.26 2.13 Asset Turnover 1.08 1.39 1.39 ROE 13.23% 12.98% 19.28%

Source: S&P Capital IQ, Team Estimates

Cash Conversion cycle weakening, but still better than the peer average. Prior to 2010 JJSF’s cash conversion cycle was one of the best in its peer group; however, an increase in days inventory on hand and decrease in days payables outstanding have served to pull up JJSF’s cash conversion cycle towards the peer group median. The latter appears to be a prudent use of some of JJSF’s excess cash, but the former bears watching. In 2011 inventories increased by 25%, 60% of which was driven by higher unit costs of inventory and inventory of handhelds Strong growth in cash flow JJSF has grown its unlevered TTM free cash flow by at an impressive CAGR of 13% over the past 10 years. This cash flow, when combined with the assets already on place on the balance sheet, provide the firm with ample cash to invest in growth assets or return to shareholders through dividends and buybacks.

11%

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2009 2010 2011 2012 TTM

JJSF! GICS subindustry!

Peer goup!

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3-Year CAGR

Revenue Net Income

JJSF 7.6% 10.0%

GICS sub-industry 5.2% 0.0%

Peer Group 7.0% 6.3%

Figure 27: Quarterly LTM Unlevered Free Cash Flow


Figure 28: YoY Change in Segment Sales

Source: S&P Capital IQ Figure 29: Drivers of segment sales growth

42 years of record revenues and profitability For JJSF, the year 2013 was a record year in terms of revenue, net income, and earnings per share. The Company’s soft pretzel brands grew by over 18% and contributed a record $145,030,000 to revenues in 2013 – though handhelds do still remain the companies single largest product segment by accounting for 32% of total sales to external customers. The repair and maintenance category continues to be a steady source of cash from the Frozen beverages segment, while the Retail Supermarket segment continue to experience headwinds as sales decreased 5% on a YoY basis, adjusting for the extra week in fiscal 2012. We anticipate the retail segment will stabilize and return to growth in the first half of our high growth period in our DCF model. We expect net income to continue to increase at a faster rate than the top line as JJSF continues to cut costs and increase operational leverage.

Investment Risks Market Risk: Change in insider ownership Since we like to see management teams have “skin in the game,” we are pleased to see that insiders have a significant stake in the company. However, it must be noted that Gerald Shreiber currently controls the vast majority of insider 3,678,745 shares, or 20% of shares outstanding7. We would become concerned if were to see insiders begin to reduce their ownership in the company as this could serve to put downward pressure on the stock by significantly increasing the float. Currently free float shares as a percentage of shares outstanding is 79.6%. For perspective the peer group median is 95%.

Operational Risk: Overpaying for growth When firms seek to grow though acquisitions there is always a risk firm will end up overpaying and destroying shareholder wealth. Though we applaud JJSF’s management team for ability to resist the temptation to do so, investors must remain cognizant that the majority of deals do not end up creating shareholder wealth.

Operational Risk: Recent financial statement developments persist over time JJSF’s accruals tend to be higher than its peer group and have shown considerable variability over the years, with large spikes occurring in 2004 and 2012. Though this does not currently concern us since large spikes have historically been followed by a regression towards the peer median, if the spike seen in 2012 is not accompanied by future decreases in the ratio we would certainly become concerned as research has found a high level of total accruals to be correlated with both an increased frequency of earnings restatements and negative abnormal returns around said restatements8. The deterioration of aggregate accruals recently is due in large part to the increase in accounts receivables. This also holds true for the separation between the growth rates for revenues vs. accounts receivables and operating income vs. cash flows from operations (please see appendix 10).

7 J&J Snack Foods Corp., (2014) Form DEF14A 8 Richardson, Tuna, and Qu (2002) Predicting Earning Management: The Case of Earnings Restatements

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Figure 30: Aggregate Accruals Figure 31: Spot and Future Commodity Prices January 1, 2009 – July 29, 2014 Source: S&P Capital IQ

Operational Risk: Loss of major customers JJSF relies on large customers for several of their products, including distributors such as Costco and restaurant chains such as Taco Bell. If they were to lose one or more of these large customers, it would have a materially negative impact on their current operations. Most purchasing decisions are made based upon consumer demand as well as the pricing of JJSF’s products, not contractual agreements, so this poses a relatively significant risk to their business. This also serves to increase the concentration of risk in their accounts receivable.

Operational Risk: Management turnover Were Mr. Shreiber or other key executives to leave unexpectedly or without having a groomed replacement for the newly vacated position we would have to reconsider our thesis since we attribute much of the firms’ prior success to the abilities of JJSF’s management team.

Operational Risk: Unanticipated spike in input costs of Commodity Prices Since raw materials such as wheat, sugar, and various dairy products are key inputs in many of JJSF’s products, there is always the risk that an unanticipated spike in certain commodities could have a sizable negative impact on margins. Economic Risk: Risks Associated With Foreign Operations Although JJSF is currently minimally involved in foreign operations, we currently see this as a potential catalyst for additional upside. However, the opposite is also true as venturing into new markets in foreign countries presents a hosts of new challenges that must be over come in addition to the added foreign exchange rate risk.

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Peer median! JJSF!

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Wheat (CBOT) Future Contracts!

Wheat (CBOT) Historical Pricing!

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Sugar #11 (ICE) Future Contracts!

Sugar #11 (ICE) Historical Pricing!

Appendix 1: Income Statement

(USD mm except per share items) Income Statement 2011 2012 2013 2014E 2015E Revenues 744.07 830.80 867.68 928.19 1003.13 COGS 514.30 580.61 604.4 643.60 695.10 Gross Profit 229.77 250.19 263.28 284.59 308.03 Gross Profit Margin 30.88% 30.11% 30.34% 30.66% 30.71% SG&A 152.70 164.80 166.50 178.20 192.50 Profit from Sales 77.07 85.39 96.78 106.39 115.53 Other Operating Expenses/(Income) 0 0.1 -0.7 0.00 0.10 Operating Income (EBIT) 77.07 85.4 97.4 106.39 115.43 EBITDA 106.99 116.02 130.66 144.42 159.62 EBITDA Margin 14.38% 13.97% 15.06% 15.56% 15.91% Depreciation & Amortization 29.92 30.62 33.26 38.03 44.19 Interest Expense (income) 0.9 (1.3) (3.4) (4.13) (4.20) EBT Excl. Unusual Items 77.97 86.7 100.80 110.32 119.63 Merger & Related Restructuring Charges -0.5 -0.2 0.00 0.00 0.00 Restructuring Charges 0 -0.2 0.00 0.00 0.00 Impairment of Goodwill 6.6 0 0.00 0.00 0.00 EBT Incl. Unusual Items 84.1 86.3 100.8 110.32 119.63 Income Tax Expense 29.0 32.2 36.4 39.81 43.41 Effective Tax Rate Percentage 34.50% 37.28% 36.12% 36.09% 36.29% Net Income 55.1 54.1 64.4 70.51 76.22 Net Income Margin 7.41% 6.51% 7.42% 7.60% 7.60% Basic Earnings Per Share (EPS) $2.95 $2.87 $3.43 $3.77 $4.11 Diluted Earnings Per Share $2.93 $2.86 $3.41 $3.75 $4.09 Dividend Per Share Growth Rate 9.30% 10.64% 23.08% 19.90% 21.03% Dividends Per Share $0.47 $0.52 $0.64 $0.77 $0.92 Payout Ratio Percentage 15.51% 17.64% 17.81% 17.98% 18.08%

Appendix 2: Statement of Financial Position

(USD mm) Balance Sheet (in millions) 2011 2012 2013 2014E 2015E Cash & Cash Equivalents 87.48 154.20 97.35 115.70 139.83 Short-Term Investments 25.51 1.21 0.26 0.17 0.11 Accounts & Notes Receivable 75.00 76.41 87.55 95.27 105.58 Inventories 63.46 69.76 71.79 80.93 92.84 Other Current Assets 8.40 6.48 7.79 7.01 6.45 Total Current Assets 259.85 308.06 264.74 299.08 344.81 Property, Plant, & Equipment 446.86 483.87 510.44 547.20 597.56 Accumulated Depreciation 322.21 342.33 363.29 385.39 416.54 Net Plant, Property, & Equipment 124.65 141.54 147.15 161.81 181.02 Goodwill 70.07 76.90 76.90 79.40 83.57 Other intangible Assets 52.00 48.46 44.01 40.79 38.63 Marketable Securities Held to Maturity 42.00 25.00 2.00 1.51 1.18 Marketable Securities Available for Sale - - 107.66 107.66 107.66 Other 2.24 3.07 3.21 3.97 5.00 Total Intangible Assets 166.31 153.43 233.78 233.34 236.04 TOTAL ASSETS $550.81 $603.03 $645.67 $694.23 $761.86

Liabilities & Shareholders' Equity Current Liabilities $75.85 $81.51 $83.24 $87.76 $94.28

Accounts Payable 55.92 59.65 50.91 50.38 50.86 Short-Term Borrowings 0.28 0.34 0.21 0.21 0.21 Other Short-Term Borrowings 19.65 21.52 32.12 39.08 48.33 Total Current Liabilities 75.85 81.51 83.24 89.66 99.39 Long-Term Borrowings 0.52 0.35 0.14 0.09 0.06 Other Long-Term Liabilities 42.06 45.71 45.72 52.01 60.21 Total Long-Term Liabilities 42.58 46.06 45.86 52.10 60.27 Total Liabilities $118.43 $127.56 $129.10 $139.18 $152.84 Total Equity 432.39 475.49 516.57 $572.05 $644.93 Total Preferred Equity - - - - - Minority Interest - - - - - Share Capital & APIC 45.02 43.01 34.52 33.70 33.58 Retained Earnings & Other Equity 387.37 432.48 482.05 540.43 616.69 TOTAL LIABILITIES & EQUITY $550.81 $603.03 $645.67 $711.01 $797.17

Appendix 3: Statement of Cash Flows

(USD mm) Statement of Cash Flows (In Millions) 2011 2012 2013 2014E 2015E Net Income 55.06 54.12 64.38 70.51 76.22 Depreciation & Amortization 29.86 30.65 33.25 38.03 44.19 Other Amortization 0.38 0.29 0.30 0.30 0.30 (Gain) Loss From Sale Of Assets 0.05 -0.1 0.13 - - Asset Writedown & Restructuring Costs -6.6 - - - - Stock-Based Compensation 0.92 1.25 1.87 2.34 2.92 Other Operating Activities 6.11 3.11 0.07 0.11 0.15 Change in Acc. Receivable -5.20 -0.60 -11.10 -11.85 -10.18 Change In Inventories -6.30 -6.50 -1.80 -4.20 -5.13 Change in Acc. Payable 4.28 5.25 0.58 1.03 1.25 Change in Other Net Operating Assets 1.87 1.98 -1.10 -1.03 0.21 Cash Flow from Operating Activities 80.46 89.43 86.55 95.24 109.94 Capital Expenditure -29.10 -42.80 -35.80 -40.23 -42.35 Sale of Property, Plant, and Equipment 0.39 1.04 1.20 1.22 1.27 Cash Acquisitions -8.81 -7.90 - 3.25 - Invest. in Marketable & Equity Securt. -25.7 41.29 -85.9 5.00 10.00 Other Investing Activities -0.60 -1.00 -0.30 -0.42 -0.42 Cash Flow from Investing Activities -63.90 -9.30 -120.80 -31.18 -31.50 Dividends Paid -8.54 -9.55 -11.47 -13.27 -14.10 Change in Short-Term Borrowings - - - - - Increase in Long-Term Borrowings - - - - - Decrease in Long-Term Borrowings -0.24 -0.31 -0.34 -0.33 -0.33 Increase in Capital Stocks 5.38 4.23 3.95 2.61 2.55 Decrease in Capital Stocks 0 -8.17 -14.50 -16.11 -17.33 Other Financing Activities -0.33 0.41 -0.20 -0.20 -0.20 Cash from Financing Activities -3.74 -13.39 -22.56 -27.30 -29.41 Net Change In Cash 12.82 66.74 -56.81 36.76 49.03

Appendix 4: Ownership Summary

36.40%!

29.90%!

4.60%!

20.48%!

8.70%!

Ownership Summary!

Institutional Stock Ownership! Institutional Mutual Fund Ownership!Mutual Fund Ownership! Insider Ownership!Other (Retail Investors)!

Total Shares Outstanding: 18,678,012!

Appendix 5: Key Financial Ratios

2011 2012 2013 2014 E 2015 E Liquidity Current Ratio 3.4258 3.7795 3.1802 3.24 3.30 Quick Ratio 2.5892 2.9237 2.3178 2.32 2.32 Margin Analysis

Gross Margin 30.88% 30.11% 30.35% 30.37% 30.40% EBITDA Margin 14.38% 13.97% 15.06% 15.07% 15.09% EBIT Margin 10.37% 10.28% 11.23% 11.24% 11.26% Earnings from Cont. Ops Margin 7.40% 6.51% 7.42% 7.43% 7.46% Net Income Margin 7.40% 6.51% 7.42% 7.60% 7.60% Levered Free Cash Flow Margin 5.16% 5.12% 5.51% 5.56% 5.58% Unlevered Free Cash Flow Margin 5.17% 5.12% 5.52% 5.56% 5.58% Asset Turnover

Total Asset Turnover 1.438 1.440 1.390 1.39 1.4 Fixed Asset Turnover 6.339 6.242 6.011 6.09 6.04 Accounts Receivable Turnover 10.272 10.974 10.584 10.59 10.62 Inventory Turnover 9.016 8.716 8.540 8.41 8.49 Total Debt/Equity 0.19% 0.14% 0.07% 0.07% 0.08% LT Debt/Equity 0.12% 0.07% 0.03% 0.03% 0.03% ROE 12.74% 11.38% 12.47% 12.33% 11.83% ROA 10.00% 8.97% 9.97% 9.92% 9.56% Solvency Debt to Equity 27.39% 26.83% 24.99% 24.33% 23.70% Financial Leverage Interest Coverage Ratio 85.633 65.692 28.647 25.7908 27.48398

Appendix 6: Equity Risk Premium Calculation

S&P 500 Dividends & buybacks TTM 80.33

Current index value 1774.2

Cash yield on index 0.0453 Enter expected growth rate in

earnings for next 5 years for market

0.0564

Current risk free rate 0.0267 Expected stable growth rate 0.0267

Period 1 2 3 4 5 Expected dividends 84.87 89.65 94.71 100.05 105.7 Expected terminal value

2050.2

Present value 78.61 76.92 75.27 73.6421057 1469.77 Implied Risk Premium in current level of Index 0.0529

Source: Damodaran (2014)

Appendix 7: Converting operating leases into debt

Converting Operating Leases into debt

Year Commitment Present Value

(In thousands)

1 $8,556.00 $8,210.34

2 7,545.00 6,947.69

3 5,820.00 5,142.74

4 4,805.00 4,074.33

5 3,072.00 2,499.62

6 and beyond 5,207.33 11,711.62

Debt Value of leases = $38,586.35

Number of years embedded in year 6 estimate 3

Depreciation on operating lease asset $4,823.29

Adjustment to operating earnings $3,266.71

Adjustment to total debt outstanding $38,586.35

Appendix 8: FCFF Summary Dollar Amounts in USD mm

Period 1 2 3 4 5 6 7 8 9 10 Terminal Year

Expected Growth Rate (%) 9.30 9.30 9.30 9.30 9.30 7.97 6.65 5.32 4.00 2.67 Terminal Year

Cumulated Growth (%) 109.30 119.46 130.58 142.72 155.99 168.43 179.63 189.19 196.75 202.00

Adjusted Reinvestment Rate (%) 57.17 57.17 57.17 57.17 57.17 50.77 44.38 37.98 31.59 25.19

Adjusted EBIT 113,214 $23,743 135,251 147,829 161,577 174,461 186,059 195,961 203,792 209,233

Tax rate (for cash flow) 36.01 35.90 35.79 35.67 35.56 35.45 35.34 35.22 35.11 35.00 35.00%

EBIT * (1 - tax rate) $72,444 $79,320 86,849 95,092 104,117 112,616 120,311 126,935 132,236 136,002 142,089.14

- (CapEx-Depreciation) 34,819 38,137 41,771 45,750 50,109 $48,356 45,448 41,430 36,404 30,530 31,181.02

-Chg. Working Capital 6,598 7,212 7,882 8,615 9,417 8,825 7,944 6,782 5,363 3,727 4,609.36

Free Cash flow to Firm 31,027 33,972 37,196 40,727 44,592 55,435 66,919 78,723 90,469 101,745 106,298.76

Cost of Capital (%) 6.69% 6.69% 6.69% 6.69% 6.69% 6.67% 6.65% 6.63% 6.61% 6.59%

Present Value 29,080 29,843 30,626 31,430 32,254 $37,589 42,547 46,940 50,600 53,389

Present value of FCFF in high growth phase

$383,298.64

Present value of terminal value of firm

$1,423,889.87

Value of operating assets of the firm

$1,808,188.51

Value of cash, marketable securities & non-operating assets $215,413.00

Value of firm

$2,023,601.51

Market value of outstanding debt

$39,309.35

Market value of equity

$1,984,292.16

Value of equity in options

$6,160.62

Value of equity in common stock

$1,978,131.54

Market value of equity/share

$105.91

Appendix 9: Autoregressive model used to forecast revenues

ln(salest) - ln(salest-2) = 0.04798 + 0.43933[ln(salest-1) - ln(salest-3) + et

Regression Results

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 0.04798 0.01532 3.13038 0.00351 0.01685 0.07907

X Variable 0.43934 0.15319 2.86773 0.00695 0.12832 0.75033

0 !

500.0 !

1,000.0 !

1,500.0 !

2,000.0 !

2,500.0 !

USD mm Modeling Revenues: Actual vs. Predicted!

Actual!Predicted!

Appendix 10: Assessing earnings quality

-‐0.6

-‐0.4

-‐0.2

0

0.2

0.4

0.6

0.8

1 Growth in operaGng income vs. Growth in cash flow from operaGons

OperaGng Income Cash from Ops.

-‐10.00%

-‐5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00% Revenue growth vs. Growth in accounts receivable

Revenues Accounts Receivable

Appendix 10: DuPont Decomposition Analysis

0!

0.5!

1!

1.5!

2!

2.5!

3!

Leverage Ratio!

JJSF

Peer median

0 0.2 0.4 0.6 0.8 1

1.2 1.4 1.6 1.8

Asset Turnover!

0%!

2%!

4%!

6%!

8%!

10%!

12%!

Operating Margin!

0%!

20%!

40%!

60%!

80%!

100%!

120%!

Interest Burden!

54%!56%!58%!60%!62%!64%!66%!68%!70%!72%!

Tax Burden!

Appendix 11: Product performance

Sales to External Customers

Food Service

2008 2009 2010 2011 2012 2013 Soft pretzels

$99,784 $99,471 $100,694 $103,943 $118,014 $145,026

Frozen juices and ices 51,206 50,272 47,273 49,740 53,813 48,831 Churros

25,286 29,404 31,732 41,583 45,974 56,099

Handhelds

8,865 27,818 26,488 Bakery

217,398 229,371 234,032 241,288 266,192 274,783

Other

6,520 9,235 23,228 18,143 9,451 9,532

$400,194 $417,753 $436,959 $463,562 $521,262 $560,759

Retail Supermarket Soft pretzels

$27,559 $30,506 $30,463 $32,044 $33,842 $34,597

Frozen juices and ices 31,742 37,819 48,288 51,940 53,673 48,077 Handhelds

9,424 24,358 22,528

Coupon redemption (2,722) (3,753) (3,399) (3,857) (3,222) (3,681) Other

533 586 767 1,548 1,217 818

$57,112 $65,158 $76,119 $91,099 $109,868 $102,339

Frozen Beverages Beverages

$113,903 $112,983 $128,125 $133,372 $135,436 $132,274

Repair and maintenance service 38,803 42,013 40,410 42,608 49,115 52,813 Machines sales

14,794 11,729 11,964 11,362 13,136 17,376

Other

2,918 2,154 2,279 2,068 1,979 2,122

$170,418 $168,879 $182,778 $189,410 $199,666 $204,585

0%!

5%!

10%!

15%!

20%!

25%!

30%!

35%!

40%!

2008! 2009! 2010! 2011! 2012! 2013!

% of !total sales! Largest Contributors to Sales to External Customers!

Frozen juices and ices! Churros!

Soft pretzels! Bakery!

Beverages! Repair and maintenance service!

Appendix 12: Market Risk Matrix

Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with the CFA Society of Philadelphia, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

CFA Institute Research Challenge

CFA Institute Global Research Challenge 2014 - University of Scranton

Economy & Finance

Transcript of CFA Institute Global Research Challenge 2014 - University of Scranton