HSY - No Longer Milking the Business

Although HSY's stock fell 6.4% yesterday in response to Chairman of the Hershey Trust Leroy Zimmerman's comments in the Patriot-News, which quieted rumors about HSY being up for sale, the Hershey Company's announcement today outlining its new long-term growth initiatives signals that the company is on the path to rightsizing its business model on its own.
  • HSY has been milking its business for some time now by underinvesting in the business and lowering its advertising spend in an effort to keep margins stable and to meet Wall Street's earnings expectations. In doing so, the company has inevitably experienced an extended period of market share declines. In 2007, this lower level of advertising was proven not enough to protect margins from the slowing top-line growth, resulting in operating income margins that have fallen off of a cliff, down over 500 bps in each of the last 4 quarters.
  • Today, the company announced that it will increase its total advertising spending by at least 20% in both 2008 and 2009 with a focus on its core brands, which make up 60% of total U.S. sales. This increased spending will further pressure margins so they could get worse before they get better, but it should help drive sales momentum and is necessary to the long-term sustainability of the business model and more importantly, the Hershey brand.
  • The Hershey brand is by no means broken. Even in light of recent share declines, Hershey is the market leader of confections, which is the largest segment of the U.S. snack market and holds the number one position in chocolate as well with a 43% share of the market. That being said, in the past, the company failed to maintain its focus on its core brands. During its investor presentation today, CEO David West acknowledged that the company overestimated [its] ability to leverage [its] confectionery scale into adjacent categories and as such, the initial success of snacks was not sustainable. This diverted key resources both financial and human, away from [its] core at a time when others were ramping up. Going forward, the company plans to focus on its core brands by not only increasing its advertising spending, but by also taking a more targeted approach. Management said it will no longer push variety into the market. We'll optimize our portfolio brands against the biggest opportunities that maximize incrementally. The company also stated its continued focus on improving its cost structure by executing on its previously announced global supply chain transformation program. Despite these cost savings, management is expecting 2009 to be another tough year from a commodity cost standpoint but still reaffirmed its commitment to investing in the brand, saying We'll do this in spite of increasing commodity costs as it is the right thing to do for the long-term health of our business. The company is now managing for the long term, rather than managing expectations...a definite step in the right direction!

Turkey Shoot!

We've called out Turkish inflation as running rampant. This global inflation problem that is scaring emerging market's is plenty clear on investor radars, finally.

The Turks decided to do something about it this morning, raising rates by +50 basis points to 16.25%.

Global Cost of Capital continues to increase, and finally some of my competitors are owning up to the reality that as Global Rates climb, Global Growth will slow.

The titanic called the Global Interest Rate Cycle, is turning.

(chart courtesy of

Chinese Stocks: What Are They Telling Us about the Olympics?

Chinese stocks continue to be under heavy selling pressure, closing down another -2.8% overnight, taking the Shanghai Index down to 2931, which is -54% from the October 07' highs. When we read the South China Morning Post in the mornings, we continue to observe local Chinese sentiment as nothing short of alarming.

I do not see any support for this Index until the 2759 line, but that's really focusing on the tree. The forest remains what big news is this stock market discounting? Since the Chinese clearly have inside information that most US centric investors do not, we need to be focused on this question, particularly ahead of the Olympics in August.

In my investment models, managing risk is about managing tail risk. We are not in the heart of the bell curve of normal distributions here anymore. China's stock market crash is signaling a major problem, and we have our Eyes on it.

(chart courtesy of

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STAGflation facts continue to emerge, but remain misunderstood...

While the Street is rightly focused on the Producer Price Index this morning, I think that the US Industrial Production report needs to be considered as well. The two reports combined, provided a direct path to the same fundamental conclusion we were beating on in our morning call note - Stagflation.

The PPI report came in well ahead of already elevated consensus expectations at +7.2% year over year headline inflation. Meanwhile, the May Industrial Production report missed expectations, coming in light at -0.2% for the month versus the Street expecting another positive #.

While US growth has not slowed (on a reported basis) yet in Q2, that has not been my call. My call is for stagflation to emerge as we exit Q2 and enter Q3.

Many Wall Street economists are calling for a Q3 "recovery". That's a hope, not a process oriented conclusion.

(picture courtesy of:

Goodbye Goody's

It's funny to me that for so long, so many of us would walk the retail landscape and occasionally ask why does XYZ brand/retailer need to exist? Despite those questions, so many marginal brands and retailers managed to hang in there with enough operating cash to service their lease obligations and sustain a fairly miserable existence. Many investors came to (falsely) believe that these entities were like cockroaches - they simply could not be killed.

Well, that was in an easy margin environment for this industry, and an easy credit environment for both strategic and financial buyers. Guess what we're in something called a bankruptcy cycle. These marginal players can, and will go bankrupt. Goody's is one of the first to file (after Linen's n Things and Sharper Image) but certainly won't be the last.

There are some interesting trends in going through the list of creditors - which Goody's filed as between 25k-50k. The biggest is Levi Strauss at $9mm. Lee is rather meaningful at $4.7mm - though this is only $0.025 (half a percent) per share for parent VF Corp. Skechers' exposure is surprisingly high at $1.9mm ($0.027 ps, or 1.5%), and Jones Apparel Group is about $2.5mm ($0.02 ps or 1.5%).

One of the more notable points is that out of the 30 companies listed as creditors, I've only heard of 8, and my extremely hip interns have only heard of 5. Goody's is not exactly a fashion mecca, but clearly the major vendors saw this coming. It's a shame Wall Street did not see the same.

PS: Note the snapshot from the Goody's website below. The promotional code for the extra 50% discount is TNT (i.e. Boom). Seriously, I'm not making this up.

MCD - The Stress is Emerging

In February, McDonald's gave away its McSkillet Burrito with the purchase of any medium or large drink for two days. In April, an internal memo urged franchisees to cut the price on its 32-ounce soft drinks to $1 in some markets, and on May 15, its newly launched Southern Style Chicken Sandwich/Biscuits were free with the purchase of any medium or large drink. And everyday, there is the Dollar Menu.

Today, Crain's reported that a panel of MCD's owners that sets national advertising for all 14,000 U.S. restaurants is resisting the company's plan to give away more chicken sandwiches in August as a result of rising food costs. The article highlights the issues that can emerge within the typical franchise business model when the franchisor (McDonald's) puts driving sales, on which it collects a royalty, ahead of franchisee (85% of MCD's U.S. system) profitability.

I have written extensively about the issues surrounding the Dollar Menu and how it is impacting franchisee's bottom lines and now these same problems are surfacing around the company's recent promotions. Ed Bailey, who owns 60 restaurants in Texas, said, There is no question the tension is greater now than it has been in some time. He estimates that the May 15 Southern Style Chicken giveaway cost franchisees about $600 per restaurant and that despite a 7% increase in sales last year, his profits were relatively flat due to higher costs.

The article also states that food and paper costs are expected to increase $32K-$35K per restaurant this year and the franchisees (again 85% of the system) are absorbing the brunt of these rising expenses. Another MCD owner with five locations in Oklahoma said that in voting against a second chicken promotion in August that franchisees aren't pushing back but rather making an intelligent business decision.

At the same time franchisees are facing pressure on the bottom line, they are being told to invest their own capital in the infrastructure necessary for the company's extended beverage as I have said once before regarding MCD's U.S. system, where there is smoke, there is fire!

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