Hershey’s big turnaround
Posted
Jul 17 2008, 02:55 PM
by
Anthony Mirhaydari
Rating:
One of the best ways to play a recession is to buy candy, chocolate and other treats that have a big impact on the brain's pleasure center.
Unfortunately, Hershey, America's largest and arguably most iconic confectioner, has been a dog with lots of problems: a lame product portfolio, strengthened competition, rising materials costs, inefficient operations and a lack of exposure to blossoming international markets.
Now, with shares trading at five-year lows, a recovery may be underway.
To be fair, some of the issues have hit the entire industry. Just look at cocoa. Prices have jumped 50% this year on fears of tight supply. Poor quality mid-crop beans out of Ivory Coast, along with disease and political unrest in Indonesia, are responsible. There is also concern that ballooning demand from Asia's emerging middle-class could lead to shortages.
There has been some improvement on this front, with cocoa futures down significantly from early July highs. The International Cocoa Organization continues to forecast a small surplus for the year and believes stockpiles will remain stable at 40% of consumption. Moreover, most of the world's cocoa is produced on small family farms that, with better equipment and training, could easily boost crop yields in response to a sustained increase in prices.
But bigger issues can be directly placed at the feet of Hershey's management. Commanding a 43% share of the U.S. chocolate market, confidence led the company to cut advertising expenditures from 4.5% of sales in 2001 to nearly 2% in 2006. Profitability improved over the period, but the seeds of self-destruction were sown. Market share and sales trends turned negative.
Last month the company outlined a new plan of attack, which focuses on a demand "pull" strategy of increased ad spending, new products and in-depth research into changing consumer tastes. Recently launched items like smooth and creamy bite-sized Hershey's Bliss and Starbucks branded chocolates, as well as its premium artisan chocolate, will be supported by marketing budgets of $162 million in 2008 and $206 million in 2009. Compared to the $130 million spent last year, Hershey's is getting serious about rebuilding its image as the chocolatier of choice.
The efforts are already beginning to pay off. Research by Citigroup's David Driscoll shows retail sales trends for both convenience and traditional grocery channels are up around 4% year-over-year; a marked improvement from the 6% declines seen late last year. Internal first-year sales projections for Bliss are also being exceeded.
Accompanying this top-line progress, Hershey is beginning to ramp its Global Supply Chain Transformation initiative launched early last year. Total annual savings of roughly $190 million are expected by 2010 though the consolidation and reconfiguration of production facilities. As part of the plan, 3,000 U.S. and Canadian jobs will be eliminated in favor of 1,500 positions at a new facility in Mexico.
Notwithstanding a revival of its core chocolate business, two wildcards remain: How will the company expand the meager 14% of sales generated outside the U.S., and how will controlling shareholders at the Hershey Trust react to all the M&A action in its space? Joint ventures in China and India are in their infancy, but are promising given Asia's cultural resistance to chocolate's taste and waist-enhancing reputation.
I'm more worried about the Hershey Trust, which thanks to a dual-class share structure controls 80% of the voting rights. Its culture seems insular. Back in 2002 it put the company up for sale, only to withdraw the offer months later. Now, it refuses to even consider a sale. The trust recently sacked much of the company's board, and installed a new CEO. Let's hope for no more distractions as the new team executes on its plan.
Citigroup's Driscoll is looking for earnings per share of $2 next year and $2.16 in 2010. With a price / earnings multiple of 21.5, the mid-point of its 10-year historical range, Hershey's shares could move well into the $40s over the next 12 months. Combined with a 3.6% dividend yield, this is a rare opportunity to profit from one of life's simpler pleasures.
(Disclosure: I don’t own shares in the companies mentioned)
Related reading:
Candy bars: The fix is in
Dark days for Starbucks: Job cuts and store closures
