The Chocolate King Outlines Robust Growth Plan
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Hershey (NYSE: HSY) started out the week of June 25th on a high note with its global expansion and long-term growth projection presentation. The company’s management hardly made the prospectus a light read – at 250+ presentation slides – but the projections do show that there is reason for non-Hershey investors to take a closer look into the corporation’s growth story. What are some of the highlights?
Hershey is a domestic-based confections powerhouse with production facilities in 14 countries and products available for sale in over 70 countries. The corporation retains ownership over a huge portfolio of household chocolate and sweet candies names including its top five global brands – Hershey, Kisses, Reese’s, Ice Breakers, and Jolly Rancher – as well as popular secondary brands including KitKat, Whoppers, Twizzlers, York, Almond Joy, and Mounds.
Despite being discretionary income driven purchases, the sale of Hershey’s chocolates and other candies have experienced meaningful demand growth throughout the past several years of global economic slowdown. The corporation’s sales hardly skipped a beat as many competitors’ top lines bottomed out in 2009, and significant gross and operating margin expansion has fueled rapid EPS growth as of late.
Hershey’s presentation shows that an attainable, albeit robust, plan has been outlined to maintain this performance over at least the next five years.
Strong Domestic Market
The snacks business is not small peanuts in the United States, and Hershey’s performance (as well as ever-increasing pant sizes) shows that Americans are very serious about their sweet treats. The $80 billion per year domestic industry is primarily controlled by Hershey-like confections, which comprise around 41% of the industry’s annual sales. The domestic snacks industry is highly fragmented, however, and close competitors including Nestle (NASDAQOTH: NSRGY), Kraft (NASDAQ: KRFT), and even Pepsico (NYSE: PEP) have huge stakes in the salty snacks, cookies/crackers, and breakfast bars niches, which represent 26%, 16%, and 10% of the $80 billion industry, respectively.
Improvement in Hershey’s domestic market will continue to be driven by modest sales increases as well as efficiency gains from streamlining initiatives. The CMG food category (candy, mint, gum), which represents the majority of Hershey’s offerings, is actually a very productive top-ten food/drink category in the domestic market. Good for Hershey’s top line (and undoubtedly bad for broader health concerns), CMG products have actually overtaken key food staples including packaged meats, milk, and cheese in terms of annual sales volume. With such products having already penetrated 98% of American households, low-to-mid single digit yearly sales growth can still be reaped out of the category with minimal advertising efforts.
Hershey also plans to retain its positive operating margin expansion through additional production restructurings. By the end of 2012 the corporation plans on having 10 confectionary facilities and 3 distribution centers in North America, which is down significantly from 17 and 5, respectively, only five years ago.
Despite the maturity of individual names within Hershey’s product portfolio – Hershey’s chocolate bars and Kisses were both launched over 100 years ago – there is still a significant amount of excitement that can still be built into the corporation’s offerings. The majority of this excitement will revolve around product innovation, which itself comes in several flavors:
- Hand-to-Mouth Evolution: Hershey’s has miniaturized a large portion of its portfolio into bite-sized treats. The “Pieces” product line (Reese’s Pieces, Almond Joy Pieces, etc.), the “Minis” product line (Reese’s Minis, Rolo Minis), and other offerings including Twizzler Bites have been some of the more popular products in the category.
- Functional Benefit Evolution: Most foods are acceptable in moderation, even including Hershey’s chocolaty treats. Several Hershey products are now individually wrapped (like the original Hershey Kiss) to promote portion control and to come across as being a more “health conscious” choice among key consumers.
- Brand Extension Evolution: Innovations can come through the addition and subtraction of ingredients from popular product lines. Jolly Ranchers, for example, can be filled with a Tootsie-Roll-like chewy center to create Jolly Rancher Crunch ‘N Chews. Peanut Butter can be extracted from the inside of Reese’s cups and sold in individual packages on shelves adjacent to J.M. Smucker’s Jif Peanut Butter. Hershey has shown that the possibilities are endless when it comes to brand extension initiatives.
The beauty behind such organic growth is that it takes little incremental R&D efforts to create new horizontal product categories after the initial product has been created. Hershey plans for very robust growth in the international segment as product extension continues to meet the local flavor profile of different overseas markets over the near future.
“Emerging markets” is one of the most buzzed keywords over the past decade as traditionally domestic-based corporations continue to seek new growth in fast-growing nations. Hershey’s five-year growth plan is no exception, and the corporation has a special advantage when it comes to unlocking such attractive growth (the international language of chocolate). Despite the corporation’s age and its deep penetration in the United States market, Hershey is still relatively young in the international space. Roughly 15% of the corporation’s sales stem from foreign countries – with Canada representing around a third of that sales volume – so there is definitely a significant amount of room for Hershey to infuse its top line with solid international growth.
Luckily for Hershey -- which may be somewhat late to the international game when compared to much more ingrained corporations including Kraft (15% of international confections industry), Mars/Wrigley (14%), and Nestle (8%) -- the high fragmentation of the industry will not prevent an extremely strong new entrant from building a meaningful base. Hershey, by comparison, currently controls less than 5% of the international confections market.
The ubiquity of the product Hershey sells also makes it rather difficult for other competitors to preclude Hershey’s deeper penetration of the international space. Nearly half of the channel distribution for such product categories is comprised of sales from dollar stores, wholesale clubs, drug stores, and convenience stores, with the other half stemming from supermarkets and mass merchandisers. With huge growth of all of these shopping channels in key international markets, Hershey’s product will almost receive a free boost in terms of reaching deeper market penetration levels.
The corporation’s international growth plan is a very close replication of its original United States expansion initiative. Using its five international brands, Hershey has intentions of further targeting the fastest growing, largest population, and highest middle class populations, which points to key markets including China, India, Indonesia, and certain Latin America markets. Sales grew at a 11.4%, 13.5%, and 27% CAGR in China, Latin America, and India, respectively, over the past five years, and Hershey management does not expect a significant slow down over the next five year period.
Is Hershey a Buy?
In combination with its five-year growth plan outline, Hershey also updated its long-term growth prospects. The corporation now has expectations of growing EPS 8-10% per year, up from 6-8% in original forecasts. Largely growing through acquisition in the international space, Hershey also has targeted $10 billion in sales by 2017 – a 9% CAGR from estimated 2012 levels, which compares to 5% sales CAGR over the past five years ending fiscal 2011.
With reconfirmed guidance for $2.82-$2.92 in diluted EPS for fiscal 2012, the corporation sells for slightly less than 25x earnings. Although this does not appear extremely inexpensive on the surface, it does compare to the stock’s past five year average P/E of 26.3x. If Hershey’s growth is expected to kick into overdrive over the next five years, the stock could very well be deserving of a few additional P/E points.
With a ten-year average of paying out more than 57% of its EPS in the way of dividends, Hershey is also no dividend slouch. Investors looking for shareholder-friendly cash use, a solid product portfolio, a safe core domestic market, and an undoubtedly lucrative future option on international growth should look no further than confection king Hershey.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services recommend PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.