Cocoa Demand Slips; Is Hershey Next?

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Chocolate is supposed to be one of those indulgences that is considered recession proof. Granted, the U.S. is no longer in recession, but it is standing face-to-face with a fiscal cliff that threatens to raise taxes and slash government spending. Nonetheless, economic uncertainties are supposed to be conditions that drive demand for cocoa, but that's not the case presently.

Cocoa prices fell 2.6 percent based on December delivery contracts on the ICE futures market, based on data cited in The Wall Street Journal. Indeed, according to Citibank commodities expert Sterling Smith cited in the WSJ, weak economic conditions stemming from Europe and threatening conditions in the U.S. have created a breeding ground for lower cocoa prices.

Hedging Cocoa

Lower cocoa prices are not something that would immediately lower costs for companies using cocoa beans as a primary ingredient, such as The Hershey Company (NYSE: HSY) Hershey hedges its purchases of the raw material as much as 2 years in advance, and as a result short-term fluctuations in cocoa prices are not immediately passed along to consumers.

Waning demand, however, is more likely to reach chocolate companies like Hershey more readily, and unfortunately that's precisely the card that the market has most recently dealt the industry. In the 3Q, demand for cocoa grindings, which are an indication of demand for chocolate, fell 16.2% and 2.2% in Europe and in North America, respectively, according to Barron's

Hershey was well aware of the economic headwinds both in the U.S. and internationally when it provided its financial guidance for the remainder of this year and 2013. Nonetheless, the company appears confident that it is in an enviable position and seems to have demonstrated that optimism by raising its quarterly dividend by $0.04 to $0.42 last month. Hershey also grew its net sales by 7.5% in the 3Q versus last year’s period. Sales were boosted some 2.3% by Hershey's recent $172.9 million acquisition of Brookside Foods, a Canadian chocolate maker.

Sweet Outlook

Hershey estimates that 2012 earnings results will come in a range of $2.87 to $2.92 per share. This compares with 2011 diluted EPS of $2.74. 

In 2013, Hershey is projecting that net sales will increase between 5% and 7%. The company does not anticipate "input cost inflation" in 2013, according to the company's 3Q earnings report, and as a result is planning to grow margins and earnings next year. Earnings per share are expected to increase between 8% and 10% on a diluted basis. Hershey, with a market cap of $15 billion, has seen its shares advance 15% year-to-date.

Kraft's Fortuitous Split

Kraft Foods Group (NASDAQ: KRFT) probably couldn't have timed its split into two separate companies any better. Last month, Kraft separated itself from chocolate maker Cadbury via a spin off to focus on its North American business. Cadbury now operates under the newly formed company, Mondelez International (NASDAQ: MDLZ).  In a recent comparison performed by the WSJ, the publication pointed out a dividend yield of 4.2% for Kraft versus a 2% dividend yield for Mondelez, suggesting that profit growth potential is more promising at the newly-formed spin-off company.

Market Headwinds

The recent conditions for cocoa are reminiscent of what has been taking place in natural gas -- lower prices and plenty of supply. And despite typical, nasty weather conditions this time of year in Africa and Indonesia that would have interrupted cocoa supply and in doing so probably lifted prices, El Nino is expected to bypass the region this year. North America and Europe's love affair with chocolate may be on hiatus, but sparks should fly again soon with Valentine’s Day in the not-too-distant future.

Know What You Own

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