Unwrapping Hershey $HSY 🍫
America's favourite confectionery company.
A quick note before the write up. I’ll be taking some time off for my honeymoon in February, so do not plan to post for another 6 - 8 weeks.
*This report was largely written before the results on the 8th of February, 2024.
Market Cap = $38.99B
EV = $43.75B
FCF = $1.62B
FCF Yield = 3.7%
ROIC = 22.12%
EBIT =$2.37B
EV/EBIT = 18.45
5 Year Revenue Growth Rate - 6%
Debt / Equity ratio - 122%
EBIT/Interest expense - 20.5
Intro
The Hershey Company, often called Hershey or Hershey's, is one of the largest chocolate manufacturers in the world. Founded by Milton S. Hershey in 1894, the company has more than 100 brands of chocolate, sweets, mints and snacks.
Hershey’s first product was the Hershey’s Milk Chocolate Bar, which was introduced in 1900. The bar was an instant success, and it helped to make Hershey the household name it is today. The company IPO’d in 1927, just before the Great Depression, and has been publicly traded for almost 100 years.
The stock is down 31% since April 2023 highs. With a P/E of 20, the ratio is the lowest it has been since 2019.
Many of the Hershey-owned brands are instantly recognisable, but the company still lags behind Mars, Ferrero Group and Mondelez International (Cadbury’s) as the fourth largest global confectionery producer. Amazingly, the two largest companies, Mars and Ferrero, remain family owned. This makes it difficult to compare on a like-for-like basis.
In 2022, Hershey generated $10.4B in revenue in approximately 80 countries. The operating margin has been consistently over 20% and is comfortably ahead of competition.
The company holds the number one spot in U.S confection and number two in U.S snacking, but lags the global reach of competitors.
Between 2021 - 2022 the company grew revenue and earnings by 16.1% and 18.5%, respectively. Over the past four decades the share price as generated a cumulative ROI 7,055.89% or an annualized ROI of 11.27%.
The Business
Hershey segments the business into three sections, North America Confectionary (NAC), North America Salty Snacks (NASS) and International.
The North America Confectionary segment makes up 81% of revenue and includes Hershey’s Chocolate, Reese’s, Kisses plus partner brands Cadbury, Kit-Kat and Rolo’s.
In the most previous quarter (Q3), revenues grew by 10.7%, driven primarily by price increases, rather than volume. Volumes in the NAC and International segments largely stagnated whilst NASS volumes increased by 22% volume and 25.5% revenue. The fact that Hershey can raise prices by almost 10% per quarter and still drive the same volume of sales is a testament to strength of the brands.
In 2022, approximately 28% of Hershey sales were made to McLane Company, one of the largest wholesale distributors in the United States. McLane distributes to Walmart (the primary retailer of Hershey products), convenience stores, drug stores, wholesale clubs and mass merchandisers.
The Salty Snack segment includes ready-to-eat SkinnyPop popcorn, Pirates Booty, Dot’s Homestyle Pretzels and other snack brands such as Paqui.
Within the International segment, the company globally manufactures and markets core brands alongside regionally targeted brands. Region specific brands include Pelon Pelo Rico products in Mexico, IO-IO snack products in Brazil and Sofit beverage products in India.
North America Salty Snacks
North America Salty Snacks (NASS) accounted for 9.9%, 6.2% and 5.4% of sales in 2022, 2021 and 2020, respectively. In 2022, NASS volumes increased by 22% volume and 25.5% revenue. The NASS segment is a growth company within a blue chip and offers new opportunities.
According to Kristen Riggs, the president of Hershey’s salty snacks division, NASS now generates $1.2 billion in annual sales. The company anticipates the ready-to-eat popcorn and pretzels will each reach about $2B in sales, having grown around 11.5% compounded over the past 2 years. SkinnyPop has been number one in sales growth for ready-to-eat popcorn over the last three years.
SkinnyPop achieved $495m in retail sales in 2022. Dot’s achieved $335m in same period and is the fastest-growing pretzel brand in the past three years, according to IRI data.
Over the next three years Hershey aims to grow margins on the salty business by 300 basis points by optimizing the supply chain network. Hershey will bring production of Pirate’s Booty in house under the Pretzels, Inc acquisition, rather than continuing to outsource production.
International
Only 8% of sales are generated outside of the US in the International segment of the business. As of the most recent earnings international revenue increased 4.4%, and was down 5.3%, the largest decline of the three reported segments.
Outside of North America, the company has plants in South America, India, Asia and the Middle East. Hershey distributes and sells confectionery products in the markets of Asia, Latin America, Middle East, Europe and Africa.
In recent years, Michele Buck, has helped turn Hershey’s international operation from losing money to profitability, a nearly $200 million upswing in five years.
Cocoa Sourcing
The cost of cocoa is up 66% from 2022 lows, from $2748 to $4583 p/ton. This is the highest the price has been since 1977.
Cocoa products, including cocoa liquor, cocoa butter and cocoa powder are the most significant raw materials Hershey uses to produce chocolate. Cocoa products are purchased directly from third-party suppliers, who source beans that are grown principally in Far Eastern, West African, Central and South American regions. West Africa accounts for approximately 70% of the world’s supply of cocoa beans.
Hershey has a trading company based in Switzerland, Hershey Trading GmbH, that hedges commodities for cocoa. Hershey Trading GmbH oversees the day-to-day program management, with teams and on the ground in Cote d’Ivoire and Ghana.
Brands
The Hershey portfolio includes a variety of chocolate brands such as Hershey’s, Reese’s and Kisses. Additional chocolate and non-chocolate confectionery brands include Jolly Rancher, Almond Joy, Brookside, barkTHINS, Good & Plenty, Heath, Payday, Twizzlers, Whoppers and York.
Reese's Peanut Butter Cups and Hershey’s Kisses make up two of the top 5 global selling chocolate brands.
The company has recently introduced a protein bar called the ONE bar. Gum and mint products include Ice Breakers, Breath Savers mints and Bubble Yum bubble gum.
Pantry products, toppings and sundae syrups are sold under the Hershey’s, Reese’s, Heath and Lily’s brands, plus Hershey’s and Reese’s chocolate spreads.
Hershey’s is in the process of expanding cross-promotion across segments. As an example, Reese’s, now includes peanut butter spreads, cookies, and dipped pretzels.
Despite Milton Hershey’s name being affixed to the chocolate bar, Reese’s is undoubtedly the company’s crown jewel. The Reese’s product consists of chocolate mixed with peanut butter.
Hershey acquired the Reese’s company in 1967. The acquisition included brands such as Jolly Rancher, Whoppers, Payday, Good & Plenty, and Heath. Six years after the Reese/Hershey merger, Reese's Peanut Butter Cups became the Hershey Company's top seller.
With annual sales of $412 million in 2020, Reese’s Peanut Butter Cups were the second highest selling US candy brand, behind only M&Ms. The Reese’s brand is featured on everything from ice cream, cereal, baked goods to jewellery, clothing and Christmas ornaments.
Acquisitions
Hershey is on the acquisition hunt, targeting savoury snack companies. This is true to CEO, Michele Buck’s, vision of becoming ‘something more than a candymaker.’
After being appointed, Buck moved quickly to implement this new strategy. In December 2017 her first acquisition was Amplify Snack Brands, the maker of SkinnyPop ready-to-eat popcorn, and Paqui spicy tortilla chips. The company paid $1.6B
The second significant purchase was in October 2018, for Pirate Brands, the maker of Pirate’s Booty, Smart Puffs, and Original Tings, which B&G Foods sold for $420 million.
One Brands, the producer of low-sugar, high-protein bars, was purchased for $397 million in 2019.
In June 2021, Hershey completed the acquisition of Lily’s Sweets, previously a privately held company that sells sugar-free and low-sugar confectionery. Lily’s products include dark and milk chocolate style bars, baking chips, peanut butter cups and other confection products that complement Hershey’s product line.
In December 2021 the company completed the acquisitions of Dot’s Pretzels, the fastest-growing U.S. pretzel brand, and Pretzels Inc. for $1.2 billion. Dot's Pretzels represents 55% of the pretzel category's growth during the past year. The acquisition brings the pretzel manufacturing capability in-house to ensure the continued growth of Dot's.
Licensing Relationships
Rowntree gave Hershey the US Kit Kat distribution rights in 1970 and similar rights in 1971 for the Rolo brand. The rights only revert to Nestle in the event of the sale of the Hershey company.
KitKat, the chocolate-covered wafer bar, was created by Rowntree’s in the UK, and is now produced globally by Nestle, which acquired Rowntree in 1988. Nestle had to honour the licensing agreement when it purchased Rowntree. KitKat was launched in 1935 as Rowntree's Chocolate Crisp. KitKat US sales are estimated at around $300 million per year.
In 1988, Cadbury was part of Cadbury Schweppes. Hershey paid $300 million for Cadbury Schweppes’ US confectionary operations, which included Mounds, Almond Joy and York Peppermint Patties, plus Cadbury products such as Dairy Milk and Carmello. Two decades later, the rest of the Cadbury business was acquired outright by Kraft, a US based company.
The Hershey facility Pennsylvania, US, produces Cadbury mini eggs, Cadbury and Carmello bars.
Hershey does not report the US sales of the Cadbury label, making it difficult to understand how much effort goes into building the brand. The deal seems sufficient to prevent Cadbury re-entering the US market. Hershey banned US imports of British-made Cadbury chocolate in 2015.
Marketing
Seasonal events, in particular Halloween, Easter and Christmas, drive around 25-30% of annual revenue. Reese's peanut butter and milk candies are a popular trick-or-treat purchases.
To capitalise on holiday seasons, Hershey introduces limited edition products, with seasonal offerings driving sales and generating excitement among consumers.
In an ongoing move to E-commerce, 5%+ of Hershey sales are now Digital. Hershey will have to remain creative to target online customers, with the majority of confectionery products purchased as impulse buys. The likelihood is that Hershey will partner with retailers who manage the online infrastructure, such as Walmart or Tesco.
Licensing
The Hershey Company is the number one US Food Licensor. According to License Global, in 2023, Hershey ranked at number 27 of top global licensors, with licensees generating $1.9B from Hershey branded products.
Licensing provides high margin revenue through royalties and ingredient sales. This also creates brand equity and further consumer engagement. Hershey has branched into a wide variety of licenced products including food and beverage, beauty products, seasonal items and accessories.
These limited editions create buzz, drive impulse purchases, and attract new customers intrigued by the cross-promotional synergies.
Locations
Hershey town, Pennsylvania, was founded by Hershey in 1903 for the company’s workers and has similarities with Cadbury’s Bournville town in the UK.
Hersheypark was founded in 1906, by Milton S. Hershey as a leisure park for the employees of the business. It remains privately owned by Hershey Entertainment and Resorts Company, owned by the Hershey Trust Company. Despite not being owned by the Hershey Company, the park heavily features they brands and allows guests to engage with their favourite confectionary.
Hersheypark is located inside Hershey's Chocolate World also includes Hersheypark, Hersheypark Stadium, Hersheypark Arena, Hershey Museum, and Giant Centre.
Hershey’s Chocolate World has 3 stores in the United States, Niagara Falls (Canada) and Singapore.
Ownership
Milton Hershey did not have any children and instead left his majority shareholding to the Hershey Trust Company. The trust now owns a minority stake but retains the majority of the voting power within the company, with around 29% of shares outstanding and 80% of voting control.
In recent years the Hershey Trust has been selling stock back to the Hershey Company. In 2022, the Company purchased one million shares for a total price of $203M, followed this with a further one million shares in 2023.
Michel Buck has been the CEO since 2017, but part of the company since 2005. Buck is behind the strategy of focusing on snacks and the expansion into savoury and better-for-you product categories. Buck owns around 126,002 share in Hershey. In the last 18 years Buck has sold an estimated value of $116.38M. These numbers do not bode well for shareholders. Frustratingly, almost half of the 2022 Annual report covers management compensation.
The Numbers
The business achieved a gross margin of 44.9% in the third quarter of 2023, up from 40.6% during the same period in 2022. Increased prices and improvements in productivity offset higher manufacturing, commodity and overhead costs. Adjusted operating profit of $753.4 million increased 22.4% versus the third quarter of 2022, resulting in an adjusted operating profit margin of 24.9%, an increase of 230 basis points.
Net sales increased 16.1% in 2022 compared with 2021, with a 4.3% attributed to the 2021 acquisitions of Lily’s, Dot’s and Pretzels.
Hershey has debt of around $4 Billion, mostly secured at a low interest rate. The company appears to be using debt to fund acquisitions. However, it should be noted that the Debt/Equity ratio is the lowest it has been for a decade.
Most Recent Earnings
Fourth-Quarter 2023 Financial Results Summary.
Consolidated net sales of $2,657.1 million, an increase of 0.2%.
Organic, constant currency net sales decreased 0.1%.
Reported net income of $349.0 million, or $1.70 per share-diluted, a decrease of 11.5%.
Adjusted earnings per share-diluted of $2.02, flat with the prior year.
Bull Case 🐂
Durable & Loved Brands
As a 130 year old company, many Hershey owned brands are almost a century old in their own right. The history creates durability and an element of nostalgia. The low price point products ensure it’s easy to incrementally increase pricing in line with inflation. This was highlighted in the most recent quarter with the 10% increase in revenue through increased prices rather than volumes.
Distribution Network and Retailers
Hershey has built a global distribution network. This network includes key partnerships with retailers, wholesalers and distributors that have been built over many decades. The size of the business ensures the Hershey can deliver products quickly and efficiently around the world.
Hershey’s Days Sales On-Hand is lower than competitors, highlighting efficiencies within the company.
The McLane Company, a leading wholesale distributor in the US, accounts for 28% of net sales. The McLane Company, is the primary distributor of the company’s products to Wal-Mart Stores. Having a single relationship with one vendor may prove risky, but ensures Hershey can focus on production and brand building, rather than customer relationship management.
Expansion into Snacks
Michele Buck is driving the business expansion through the acquisition of brands, in particular savoury snacks. The growth in these segments is obvious since North America Salty Snack volumes increased by 22% and 25.5% revenue, considerably higher than the rest of the business.
Hershey can integrate new brands into the distribution networks to optimise margins and further increase revenue. With an average of one significant acquisition per year, there’s room for further expansion.
The new brands target fresh consumer segments and offers global expansion opportunities, a move away from products that have not been embraced internationally due to geographic taste profiles.
Global Expansion
Hershey is predominantly sold in the US.
Anecdotally, Hershey brands were almost non existent in the UK during my own childhood, but now have an obvious shelf presence, especially Reese’s. However, Hershey bars have struggled to secure market share due to taste preference outside of the US and typically lose out to Cadbury products in the UK.
After World War 2 Hershey did not pursue international expansion, allowing Mars and Nestle to secure the much of the global market. In 2022, 2021 and 2020, respectively, the company derived approximately 12.5%, 13.0% and 13.6% of net sales from customers located outside of the United States. The company is slowly building international sales.
The expansion into the savoury and salty snacks market will provide additional international opportunities.
Bear Case 🐻
Dis-alignment of incentives
Mars and Ferrero are the two largest chocolate producers in the world. Each is privately owned, meaning the management do not have to appease the stock market. This ensures the owners can plan for the long term without having to navigate short term quarterly results.
Michel Buck owns around $22M dollars of Hershey stock, but has sold down approximately $116M during her tenure. The 10 members of the management team own less than 1% of shares outstanding. Despite this, 2022’s annual report contains over 40 pages discussing management remuneration and compensation. This excessive communication demonstrates where the board’s priorities lie.
Changing Consumer Preferences
Roughly two out of three U.S. adults are overweight or obese (69 percent) and one out of three are obese (36 percent). This number has been increasing steadily for four decades. It does not reflect positively on a company who sells high-sugar foods. Consumer habits could significantly shift as customers search for low-sugar and healthier brands.
GLP-1 drugs have been introduced to combat obesity and reduce food intake. A decrease of gastric emptying inhibits food intake and as a result users may feel full faster for longer and therefore eat less.
An extreme outcome could result in the US introducing a sugar tax, with various states and cities having already introduced a ‘soda tax’.
Conclusion
Hershey is a business with numerous beloved brands, inflation proof products and low maintenance capex. The company appears to be navigating consumer spending headwinds sufficiently. Margin expansion may prove harder to come by in the short term, in particular with exposure to recent coca pricing fluctuations
The company has maintained growth after achieving 16.1% net sales increase in 2022. Hershey is dominant in the US and has scope for international growth. The business is growing through strategic acquisitions - particularly in the savoury category.
It should not be overlooked that Hershey products are up against some of the largest global brands and producers. Hershey is not the dominant player in the confectionary industry, Mars generates four times the amount of revenue. The story of Hershey is not complete without Mars, and was well covered in the Business Wars podcast. Mars annual revenue is higher than Coca-Cola, an astounding feat for a family held company.
Michele Buck appears to have rejuvenated the company’s strategy, but questions remain regarding management’s lack of ownership.
With over 100 years of history and a 30% decrease in share price, the shares are more attractively priced in comparison to recent years. However, with 2024 revenue increase forecast at only 2% to 3%, the company is not primed for growth.
Resources and Further Reading
https://hershey.gcs-web.com/static-files/2227ed0e-784d-488e-b30e-5ae5e5a4fdcc
https://hershey.gcs-web.com/static-files/cd05dfb5-cf55-415e-a195-7b946e6d9c71
https://thebrandhopper.com/2023/09/10/marketing-strategies-and-marketing-mix-of-hersheys/
https://hbr.org/2022/11/the-ceo-of-hershey-on-turning-a-candy-company-into-a-snacks-empire
https://qz.com/subway-meat-slicers-1851195872
https://seekingalpha.com/article/4665512-is-hersheys-really-such-a-sweet-deal-here
https://www.investorschronicle.co.uk/ideas/2023/11/23/hershey-s-pricing-power-protects-it-from-weight-loss-risks/
https://www.pennlive.com/food/2020/10/reeses-expanding-brand-is-the-economic-engine-driving-hershey-companys-growth.html
https://hershey.gcs-web.com/static-files/332e9099-d69b-43a1-af08-06204f8e0ec8
Any thoughts on Bear Caves short report that Mr Beast is taking a share of Hershey’s market?