Chocolate Investment: Discrepancy Between Price and Value

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Eating lots of food is one of the best things to look forward to on the holidays. This simple fact also makes a good investment thesis. One specialty food company that stands out is The Hershey Company (NYSE: HSY). Hershey is one of the most well-known chocolate producers in the world. The company was founded in 1894, operates in over 90 countries, and employs approximately 14,000 employees. Hershey has many iconic brands, such as Hershey’s, Hershey’s Kisses, Reese’s, and Kit Kat.

Chocolate

Hershey’s strong brand name is fueled by its strong business success. In the past five years, Hershey has a compound annual growth rate of (CAGR) of 4.23%. In comparison, competitors Nestlé (NASDAQOTH: NSRGY) and Mondelēz International (NASDAQ: MDLZ) have CAGRs of negative 3.21% and positive 10.33%, respectively. Mondelēz International is the former giant Kraft Foods--Kraft Foods changed its name to Mondelēz International on October 1, 2012 and in the process spun off Kraft Foods Group (NASDAQ: KRFT). The changes left Kraft Foods Group in charge of the North American grocery business and Mondelēz in charge of the global snacks business of the former Kraft Foods. The split was done to increase focus and shareholder value after Kraft made the $20 billion acquisition of Cadbury in 2010. Due to these events, a direct comparison between Hershey and Mondelēz is probably not completely accurate. However, Kraft Foods was already a force in the chocolate industry before it bought Cadbury.

Anyway, despite having slower growth than Mondelēz, Hershey has higher margins. In the trailing twelve months (TTM), Hershey and Mondelēz have operating margins of 16.83% and 11.62% respectively. Also, Hershey is more efficient. In the TTM, Hershey and Mondelēz have return on assets (ROA) of 14.73% and 3.46%, respectively. Nestlé has a TTM operating margin of 14.82% and an ROA of 8.6%. ROA is a good measure of business efficiency because it measures the amount of money the company is generating with its assets. Good managers are able to generate big returns on assets. The following chart compares ROA for Hershey and Mondelēz in the last 10 years.

<img src="http://media.ycharts.com/charts/98c3473046214c7b5c55c3b63f5ae525.png" />

MDLZ Return on Assets data by YCharts

As shown, with the exception of years 2008 and 2009, in the past 10 years, Hershey has been efficient and has overall generated an ROA of over 10%.

Q3 Earnings

Looking at the most recent quarter, in Q3 2012, Hershey reported a 7.5% increase in net sales and a 10% decrease in net income year over year. However, the decline in net income is not as bad as it seems. The quarter included onetime costs for its Project Next Century and costs related to its Brookside Foods acquisition. Project Next Century and the Brookside Foods acquisition had pre-tax charges of $25.8 million and $4.8 million, respectively. Excluding these costs and a non-service-related pension expense (NSRPE), Hershey earned $199.5 million, which was up about 2.8% year over year.

In the earnings call, while talking about opportunities in India, Hershey CEO John Bilbrey said, “Similar to what we've done in other international markets, we'll make disciplined brand building investments and improve upon selling capabilities and expand distribution. We'll focus on expanding margins via aggressive cost control and margin enhancing innovation while also evaluating the global Hershey portfolio to determine the best products for the India consumer and marketplace” (Seeking Alpha). The focus on costs and margins points to an efficient future for Hershey.

The Bottom Line: Value

Looking at value, Hershey currently has a PE ratio of 25.7 and a tangible book value per share of $0.74. Tangible book value can usually be considered as a discount to the cost of investment because it is equity already owned by the business. However, a PE of 25.7 is not cheap and Hershey’s tangible book value does little to change that fact. Using the high range of the EPS forecast of $3.22 to $3.25 for the full year, gives Hershey a forward PE of 22.6, which is still not cheap. In addition, the company has about $2 billion in total debt and only $500 million in cash and cash equivalents. Hershey is a good company, but at this price level, Hershey should go on the watch list.


iamgreatness has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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