Summary
- Investors might not outperform the market initiating a position in HSY today, but they do provide a sense of safety in a very uncertain period.
- In the long-run, Hershey’s is going to be just fine, as it has for the last century.
- The biggest risk we see is how they are going to perform in the Halloween and Holiday season.
- We believe shares in HSY are trading within their fair value estimate.
The Hershey Company (HSY) is as solid as any business could get. The company is a defensive stock that smoothly sails in economic booms or busts. Their products target every consumer palate, from iconic brands like Kisses and Reese’s to newly acquired salty snacks with Pirate Booty and SkinnyPops. The company is also venturing into the healthy snack trend (protein bars), helping them to boost sales.
We believe shares in HSY are trading within their fair value estimate. First-quarter results were not affected by COVID-19 disruptions but were not stellar either, especially if compared to other competitors in the package food industry. However, those results were to be expected, as consumers were stocking up on long-shelf-life consumables, toilet paper, water, etc. Candy is not the first choice when a national emergency takes place.
Investors might not outperform the market initiating a position in HSY today, but they do provide a sense of safety in a very uncertain period. That said, the biggest risk we see is how they are going to perform in the Halloween and Holiday season. Their North American market accounts for 89% of total sales. In our opinion, HSY is going to have a weak second half, as the fear of contagion is still fresh in the consumer's minds. Weak sales can be a trigger for lower share prices, which in our opinion, could become an interesting place to start a position. One thing is certain, with HSY huge market share and competitive advantages, we believe it wouldn’t take long for the company to make a recovery.
Looking at their numbers
Source: company filings
The strength of the business can be appreciated by looking at their reported numbers. We like businesses that do not have wild fluctuations in their operations. HSY is a clear example. The company reports steady numbers each year.
HSY's top-line has been growing at a 10-year CAGR of 5%, outpacing GDP growth. It shows the company’s pricing power and leading position. HSY has the ability to raise prices to outgrow inflation in its raw materials (mostly cocoa). If we look at gross margins, we see increasingly steady margins throughout a 10-year period. Throughout a business cycle, we believe it is safe to assume that they can sustain gross margins in the 42%-44% range.
In the second half of 2010, HSY began restructuring its manufacturing operations in what they called “Next Century Program”. It was an effort to revamp its supply chain and align its cost structure to a more competitive environment. As part of the program, HSY moved production from its century-old manufacturing facility to a more modern plant. The program was finished in 2014 for a total cost of $197M, in-line with management expectations.
Contributing to the expansion of operating income margins is the tight control over G&A expenses. Reaching a high point of $1.3B in 2015, G&A costs have remained flat, while revenues grew by approximately $600M from 2015 to 2019. Incremental revenues plus operating leverage has allowed HSY to expand operating income margins from 19.8% in 2015 to a recent 21%. The control over G&A expenses was also the result of another restructuring program started in mid-2015. The goal was to simplify the organizational structure, which resulted in the net reduction of approximately 300 positions. The company also started optimizing their international operations, which were facing headwinds, especially in the Chinese market, resulting in facility consolidations.
