Hershey Living 'Hand to Mouth'

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The Hershey Co. (NYSE: HSY) has been hitting 52-week highs almost daily lately. North America’s largest confectioner has run from the mid-30s in 2009 to $72.97 earlier this month. Founded in 1894, it reported on July 25 that 2Q EPS was $0.66 a share, improving gross margins and guiding higher for the year, predicting 12-14% EPS growth versus expectations of 10-12%.

Living ‘Hand To Mouth’

But it wasn’t just earnings moving the stock. Hershey’s has been implementing a "hand to mouth" portioning of many of their 25 brands into bite-size pieces. Without having to change anything except wrapping and labeling, they are creating a psychological sea change for snackers who will probably be eating just as much candy (if not more!) but feeling better about it.

In addition they are beginning a major launch of ”Simple Pleasures” candy with 30% less fat. You may have already seen TV commercials of an entire office breaking into dance after the ecstasy of eating Simple Pleasures at their cubicles; what the admen like to call a "funny-cute." This is the first major rollout of a new product since 2007.

The hand-to-mouth portioning is well timed before Halloween and Christmas, major drivers of candy sales. This is considered their most innovative strategy this year. Goldman Sachs seems to like it, having upgraded Hershey to a Conviction Buy on June 13 with a price target of $76.00. Although for Q2 Hershey reported lower than expected revenue, analysts at Kadant and Argus maintained their buy ratings.

Hershey Bars and Nylons

Goldman cited among other things, pricing power and expected international growth. Not since WWII when US soldiers brought their Hershey bar rations and nylons to international theaters of operation to give to foreign ladies has Hershey planned more international exposure. At a June investor presentation the company said it was committed to sales expansion in Mexico, Brazil and China and to raise total revenues to $10 billion by year end 2017. How to do it? The company plans to binge on acquisitions. They swallowed up a Canadian company, Brookside Farms, in 2011 and said it is already accretive in the 2Q report. Before that they acquired some small but strategic companies including Mauna Loa Macadamia Nut Corp. (can dark chocolate-covered macadamia nuts be far behind?), Dagoba Organic Chocolate and Scharffen Berger, a super-high-quality chocolatier. Hershey already has operations in 90 countries and worldwide name brand recognition.

Hershey must feel it has to make up time since Kraft Foods’ (NASDAQ: KRFT) successfully acquired Cadbury’s. Both companies were vying for the international brand but because of dissension between the majority (and controlling stockholder) the Hershey Family Trust and the Hershey board, the company lost out after Kraft CEO Irene Rosenfeld herself flew to London and outbid them. Game over. At one point Hershey was planning to team up with the Italian confectioner Ferrero to buy Cadbury’s. Again there was back and forth between the board and the Trust.

If you are interested in Hershey stock you must be aware of the Hershey Family Trust, which is the majority stockholder with voting power of 80% and will continue to be the majority holder for the foreseeable future. The Trust’s mandate is to use its profits and dividends for the Milton Hershey School, a private boarding school for socially and financially disadvantaged youth. Despite that noble calling, which should align positively with the rest of the shareholders and the Board, there have been major shakeups and dissension that contributed to a 38% drop in share price from 2005 to 2010. The Trust and the board seem to be playing nice lately but this is an underlying concern for the stock. The Trust also owns Hershey Entertainment & Resorts Co., which runs Hershey Park and ZooWorld, but those monies are not included on Hershey’s books. Complicated, I know.

Speaking of competitors, Kraft Foods' purchase of Cadbury’s worried analysts over Hershey’s ability to compete in the international arena of snacks, but Hershey’s June commitment to acquire reassured them. Hershey’s does have the highest P/E at 24.35 among the three big candy companies with Kraft/Cadbury at 20.20 and Nestle at 20.24. The industry average is 13.14. Hershey has been shaking off decades of lackluster growth and has raised their ad budget by 10% to aggressively market their brands and support the new hand-to-mouth marketing initiative.

In 2010 they started an ambitious program called Project Next Century to modernize and expand the West Hershey plant as well as other improvements to create a cost-effective supply chain. The operational savings from the project are supposed to be fully realized in 2014.

Of note is the dividend, now at 2.10% which has increased every year for the last 40 years except for 2009. Institutions love its consistency of dividend payments and hold 74.20%. As for commodity concerns for cocoa, sugar and fuel, snack and candy companies traditionally have pricing power as they are such a low-cost indulgent impulse purchase that consumers rarely notice double-digit price increases.

Kisses and Hugs

In the world of snail mail it is customary to sign off with kisses and hugs. Sweet. So old-fashioned. So what I leave you with is that Wall Street is counting on an international sweet tooth to only get stronger and for Hershey to have a major place at the snack counter. The company is on what seems to be a well-deserved growth trajectory and pullbacks should be considered as opportunities to take a nibble. Just a nibble, mind you or what Hershey's likes to call a hand-to-mouth portion. Have a few dark chocolate Hershey Kisses in my honor.



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