There is a lot to like about the Hershey Company and there are some current issues the company is facing that need to be addressed.
The three biggest issues the company is facing:
- 2H15 Domestic CMG volume performance looks aggressive but achievable
- Putting the Shanghai Golden Monkey acquisition in the rear view mirror
- Long-term growth model is under pressure from international pressures
That being said the Hedgeye Consumer Staples Dashboard is flashing positive as many of the company’s issues are being priced in:
- HSY has underperformed the SPX and XLP by 7.0%and 8.8%, respectively
- HSY is at the bottom quartile of revenue and earnings revisions
- HSY is trading at 78% of its 5 year P/E vs 85% for the group
- Short Interest is at 3%
- 83% of the Sell-Side have holds or sells on the stock
Snacking today is not just natural & organic or better-for-you; there is an indulgent side as well. HSY has a big advantage in this market with a lot of room to grow as they extend into other areas of snacking, such as premium jerky and macadamia nuts.
STOCK PRICE PERFORMANCE
The stock hit a 52-week high in January of 2015 at around $111 per share, and is now trading well below that now at $87.08.
SELL-SIDE SENTIMENT
HSY is not a well-liked stock on the street right now, especially evident by the downward trend in the stock since January. Only 17% of the analysts have it rated as a buy, 72% rate it as a hold and 11% as a sell.
INDULGENT SNACKING
Evident by the chart below provided by Nielsen, Chocolate is a global leader in snacking even when put up against healthier options. This chart further drives home our point, snacking is not just about being healthy, it’s about enjoying yourself.
Indulgent snacking is increasing the number of claimed benefits to attract consumer trials. Claims such as fiber, energy, and vegan are leading the charge and driving consumption.
LACKLUSTER PERFORMANCE
We believe that a majority of the poor stock performance can be attributed to the poor financial performance in the U.S. business as of late. Additionally, China as a whole has been struggling while only 5% of sales, managements continued investment in the region could be alarming investors. In 2Q15 overall company volumes declined -3.6%, largely attributable to price increases in the U.S. along with the aforementioned softness in the China segment. Management is adamant about turning this performance around through strategic marketing and distribution gains. We believe in the return to growth in the U.S., but remain skeptical about China in the near term.
STEPPING OUTSIDE OF THEIR COMFORT ZONE
While management stepped out of their comfort zone with the acquisition of Krave Pure Foods, it’s still snacking and we believe they are well positioned to take advantage of this brand. Jerky is one of the fastest growing premium snack segments, and this shows that Hershey is willing to venture outside of confectionary products. Another category they entered this year is nut products, with the acquisition of Mauna Loa Macadamia Nut Corp closed in February 2015. Another small acquisition, but a great tuck in brand providing additional scale outside of chocolate.
This detail on management’s interest in snacking outside of confectionary is encouraging given how many assets are available in the space. There are plenty of smaller assets out there, but if HSY wanted to make a bigger splash, one company that comes to mind is Diamond Foods (DMND). With roughly $881mm in sales through the LTM April period, it is roughly a tenth of the size of HSY. Quick math, taking into account $90mm in synergies, the deal would be $0.11 dilutive in year one and $0.01 accretive in year two. Beyond the financial aspects of the deal, fundamentally we believe this to be a great growth driver for the company in the long term as they expand their snacking portfolio.
MANAGEMENT’S GUIDANCE APPEARS ACHIEVABLE
Management’s revised outlook for the full-year 2015 appears to be achievable, calling for net sales growth of between 3.0% to 4.0% on a constant currency basis. For the full year, the company expects gross margin expansion of 135 to 145 basis points as solid North America gains, driven by price realization, are partially offset by international softness related to the aforementioned higher direct trade rate and obsolescence in China. Additionally, as stated in June, the company expects to achieve approximately $10 million to $15 million in savings related to its business productivity initiative. The company expects adjusted earnings per share-diluted to be in the $4.10 to $4.18 range, an increase of 3% to 5% on a percentage basis versus 2014, including dilution from acquisitions and divestitures of around $0.20 per share.
RISKS
A continued slowdown in Chinese consumption of chocolate could hamper the recovery in the region. Commodity price pressures in cocoa and their expansion into jerky with Krave, a heavy user of beef could increase the volatility of their ingredient basket. A shift in consumer preferences away from indulgent snacking would adversely affect HSY; we see this risk and a very low possibility. Overall the risks in our eyes are manageable, and already priced into the stock.
More to come as we further explore this company. Please call or e-mail if you want to talk through the idea.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
