Hershey reported Q3 EPS of $2.60 vs. the consensus estimate of $2.46. The upside was driven in part by more early shipments of Salty Snacks due to the ERP implementation and better gross margins. Organic growth of 10.7% exceeded consensus estimates of 8.8%.
Segments
Confectionery: Q3 Organic sales growth 10.1% with price +11.1%, volume/mix -1.0%.
Q2 Organic sales growth 4.8% with price +88.4%, volume/mix -3.6%.
Earlier seasonal shipments benefited Q3 volumes, and seasonal growth drove nearly half of the segment growth. The non-measured channels were also growth drivers. Management noted everyday chocolate sales slowing as elasticity increased as expected and a merchandising change at a key retailer. Halloween retail sales to date are up slightly YOY, and Hershey is outperforming the category. The consumer is making Halloween purchases later this year. Growth in the non-chocolate portfolio was 9%, led by gum & mint growth of 12%. Candy, mint, and gum retail sales increased 2.5% in the 12-week period ending October 1, resulting in 120bps less market share. Pricing will moderate to +HSD% in Q4 as the company laps price increases last year. Segment margins expanded 290bps.
Salty Snacks: Q3 Organic sales growth 25.5% with price +3.3%, volume/mix +22.2%.
Q2 Organic sales growth 6.3% with price +6.6%, volume/mix -0.3%.
Growth was boosted by 16% due to earlier shipments to avoid disruption from the ERP implementation. Excluding the earlier shipments, sales were up MSD%. Retail sales were flat in the quarter. Dot’s retail sales grew 36%, in part driven by permanent distribution in a club retailer. While pretzel category sales were robust, the puff and RTE popcorn category slowed considerably, impacting SkinnyPop and Pirate’s Booty. SkinnyPop retail sales decreased 3.9%, resulting in 80bps share loss. Dot’s retail sales increased 17.6%, resulting in 160bps of share gain. Q4 is expected to be similar to Q3. Segment margins expanded by 40bps.
International: Q3 Organic sales growth -1.2% with price +4.1%, volume/mix -5.3%.
Q2 Organic sales growth 6.2% with price -3.4%, volume/mix +2.8%.
Heightened competitive activity and moderating category trends led to slower growth. The company exited a lower-margin beverage product in Mexico and shipped later in India and Brazil. Management expects to see accelerating trends in Q4 for several reasons. Segment margins contracted 230bps.
Margins
Gross margins expanded 240bps YOY, improving from +130bps in Q2. Pricing and productivity gains more than offset inflation and higher manufacturing costs. Management now expects gross margins to be at the high end of the range for the year. Advertising increased 20% in Q3 and is expected to grow double-digits in Q4. Non-advertising G&A costs are expected to grow by LSD%. The company’s ability to offset higher costs resulted in modest changes in elasticity, which likely reflect the consumer environment more than the brands.
Our variance
We had modeled 1% volume growth for Confectionery but with 300bps less price/mix. The greater pricing drove more gross margin expansion than we modeled. The Street may have preferred our growth formula, but our EPS estimate was also lower.
Looking forward
Management reaffirmed the components of guidance for 8% sales growth and 11-12% adj. EPS growth. The EPS range remains $9.46-9.54. Management cited changes with the consumer cutting back on discretionary purchases, shopping at discount channels, and buying smaller sizes – notable headwinds. Despite the recent pullback in the shares and the upside to Q3 results, the earlier shipments for N.A. confectionery and salty snacks weighed on sentiment. The earlier shipments slightly shifted our estimates between quarters. Volume growth is not the end objective for the company, although the market’s hyperfocus on it suggests it is. It is difficult to see how the current decline in volumes in the context of the increase in commodity costs and the company’s pricing measures to offset that, negatively impact the company’s future earnings potential. Hershey is also not secularly challenged to grow volumes. The company has several volume drivers looking forward in smaller price increases, innovation, additional capacity, and distribution opportunities. Hershey is a Best Idea long that is attractively priced for its future growth potential and visibility in earnings measured against near term challenges presented by higher interest rates, GLP-1 drugs, and higher inflationary costs.
