Will Hershey Maintain Its Sugar High?

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When you think of chocolate, which company first comes in mind? For me it was always Hershey (NYSE: HSY). The company’s good branding and dominance in the U.S chocolate market aren’t the only things working for it. Shares of Hershey rallied in recent months. Moreover, the latest positive rating the company got from leading analysts may keep fueling this rally, unless its upcoming quarterly financial reports don’t meet expectations. Will Hershey’s stock keep rising or has it reached its sugar high (which usually follows with a sugar crash)? 

Chocolate sales are rising

Even though the demand for chocolate is rising, I have already showed how most of the growth is related to population growth and not to higher consumption per person. Nevertheless, Hershey continues to perform well and keeps showing reasonable growth in sales:  In the first quarter of 2013, revenue rose by 5.5% compared to the same quarter last year. In comparison, according to the U.S Census Bureau, sales of food and beverages grew by 2.3% in the first six months of 2013 and by nearly 3% in the first quarter of 2013. Thus, Hershey’s growth in revenue exceeded the market growth in demand.

Anther chocolate company, Mondelez International (NASDAQ: MDLZ), a spin-off of Kraft Foods, hasn't performed as well as Hershey has:  The company’s revenue rose by only 0.9%. Furthermore, Mondelez is less profitable than Hershey, as its operating profit reached only 9.5% in the first quarter. Conversely, Hershey’s profit margin rose to 21.4% in the first quarter. The higher profit margin could be related to the company’s dominance in the chocolate industry in the U.S:  Hershey’s U.S chocolate market share is nearly 43%. 

Other food manufacturers such as Kellogg (NYSE: K) have done well during the year. Kellogg's revenue grew by 12.2% in the first quarter of 2013. But Kellogg's profit margin was 13%, which is still lower than Hershey’s profitability. Albeit Kellogg is less profitable than Hershey, the former offers a higher dividend yield than the latter:  Kellogg’s annual dividend yield is nearly 2.6%; Hershey’s dividend yield is 1.8%. Mondelez International offers the lowest annual dividend yield at about 1.7%.  

Looking forward, let’s examine several factors that could affect the progress of Hershey.

Cocoa prices are slowly rising

In the first quarter of 2013, cocoa prices were nearly 5.6% lower than the parallel quarter in 2012, but the price of cocoa has slightly increased in recent months. In the second quarter of 2013, the price was 1.1% higher than the second quarter last year. One of the factors that may have contributed to the slow rise in cocoa price is the drop in cocoa production during the year: The International Cocoa Organization’s current estimate is that world production will be 2.7% lower in 2013 versus last year.

Chocolate producers, such as Hershey, hedge against the fluctuations in cocoa prices. Therefore, rising prices won’t have a direct effect on their expenses this year. But looking forward, if the price of cocoa continues to rise, this could adversely affect Hershey’s profit margin in the coming years.

Sugar prices continue to fall

Another factor that could affect the profit margin of leading chocolate producers is the price of sugar. In the past year, however, the price of sugar fell by almost 16%. This trend may have benefited the bottom line of Hershey and Mondelez International. If this trend persists, as some analysts suspect, this could keep augmenting the profit margins of Hershey in the years to follow.

International growth

In order to maintain Hershey’s growth, the company continues to expand its international segment:  In 2012, net sales from outside the U.S accounted for 16.1% of its total sales. In 2011, it was 15.6%. As the international segment continues to expand, its revenue is likely to keep rising. But keep in mind it could come at a price:  Selling outside of the U.S might reduce its profit margins as the company faces local competition; the currency risks could also reduce its revenue and profitability.


In terms of valuation Hershey’s current price is high compared to the industry’s average and compared to other leading food-processing companies, but I suspect this partly represents a higher growth in revenue than the industry’s average. By using enterprise value, I compared the EV-to-EBIT ratios of the above-mentioned companies.

The table below summarizes the data of all three companies and the food- processing industry averages. 

<img alt="" src="http://g.fool.com/editorial/images/60386/hershey-valuation_large.jpg" />

The yearly EBIT is based on the past four quarters (ending in the first quarter of 2013). As seen, Kellogg’s EV-to-EBIT ratio is the highest at 18.8, which is nearly double the industry’s average. Hershey’s ratio is also very high and close to Kellogg’s. On the other hand, Mondelez International has a lower EV-to-EBIT ratio. These findings suggest, at face value, that Kellogg and Hershey are relatively high priced for the industry. Among the reasons for their higher price are their stronger growth in revenue and wider profit margins.

The bottom line

Hershey is making great strides in keeping its revenue rising. Hershey’s current valuation is high for the industry but the company’s higher growth in revenue could be among the reasons for this. The company continues to expand its reach outside the U.S, which is likely to maintain this growth. At the same time, Kellogg might be a better bet as it offers a higher dividend, maintains higher revenue growth, and its valuation isn’t far off from Hershey’s. 

For further reading: Why Coffee Prices aren’t affecting Starbucks?

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