Yesterday’s selloff in Hershey stock was downright silly. Some analysts have sounded the alarm bell on the stock, “downgrading” it in notes to investors on the theory that the 1.5% sales growth in the third quarter was a signal of weakness.
As I’m sure this will surprise absolutely none of you, I do not see it that way. In the past year, Hershey has embarked on a series of aggressive price increases for its chocolates, mints, and gums. The whole Hershey portfolio of candies and other confectionaries saw price increases of 8%. The Reese’s brand, which has some of the most extraordinary profit margins and pricing power of any product sold over the past half-century, has seen its price go up by 12.5% in the past year.
Hershey has making its chocolate more expensive disproportionate to the 2.5% rise in the price of cocoa and all dairy input costs. It is not an unusual outcome for sales growth to slow down a bit during a year of sharp price increases. That’s a perfectly ordinary part of a corporation’s story. Hershey has grown sales by 6% over the past ten years, and the 1.5% third-quarter figure is directly tied to Hershey’s decision to increase prices at the highest rate in fifteen years. You would have to go back to 1999 to find an analogous example of Hershey raising prices at such a high rate.
I view Hershey stock in 2015 as analogous to purchasing Coca-Cola in the 1970s or 1980s, and that is about the highest compliment I can give an investment.
There are three similarities that persuade me to draw that conclusion.
The first is that company is effective at adding brands to the eponymous corporate umbrella that are nearly as profitable yet also provide new growth platforms without getting heavily into “diworsification” territory. It can license Kit-Kat, Rollo, Cadbury, and other brands through Nestle and Kraft to complement the Hershey, Reese’s, Twizzlers, Ice Breakers, and Milk Dud core portfolio. This is reminiscent of Coca-Cola moving into Fanta, Sprite, Powerade, and VitaminWater.
The second is that lucrative profit margins are retained as the company diversifies. This is the hallmark of a fantastic company operating in a fantastic industry. After taxes are paid, new factories and distribution systems are built, the ongoing acquisition costs are settled, and everything else is paid, Hershey gives shareholders $0.12 in profit on that $0.74 candy bar. Every time you see someone purchasing a candy bar owned by Hershey at the checkout aisle, you can know that you are entitled to a profit of $0.12 on that item–you just have to split the proceeds of each bar with 218,000,000 other shares. This high profit is quite similar to Coca-Cola collecting $0.28 on every bottle of soda someone picks up at the checkout line as well.
And thirdly, the reason why I find Hershey analogous to a young Coca-Cola is that the company is still in the infancy of its international expansion. Coca-Cola currently has operations in over 200 countries, and generates 80% of its sales outside the U.S. Hershey is the opposite–it generates 80% of its sales in the United States and is setting its sights on Mexico, India, and China as the next source of growth.
I do think, however, that Hershey will face a slightly more expensive path to international growth than Coca-Cola did during the past three decades. When Coca-Cola began its international expansion, it benefited from the uniqueness of its product. It didn’t have to displace an existing cola. Hershey, on the other hand, faces entrenched chocolate and sweet brands in every country it enters. It would not surprise me if the Hershey and Reese’s brands specifically had trouble growing sales abroad, and instead, Hershey had to rely on the more costly path of brand acquisitions to grow abroad.
Hershey is attractive because it has the quality of a large multinational but hasn’t conquered the world yet–suggesting wide possibilities. Hershey is a $14 billion company (in comparison, Nestle is a $294 billion company). Nestle must make large acquisitions to move the needle, and must deal with the prospect of growing in markets it already saturates. It’s a very real hurdle, yet one that Hershey must not jump. There are plenty of brands that Hershey could pick up right here in the U.S., and it also in the same place Coca-Cola was thirty years ago in terms of international expansion.
The recent 7.5% price decline, due to restructuring charges associated with the Shanghai Monkey brand of Chinese chocolate, offers a chance to get Hershey stock at a nice price. It’s either moderately undervalued, or on the low end of full value, depending on how you calculate terminal rates of growth. This is a company that generates high profits while deploying little capital. It has quadrupled profits since 1999. It is about as simple of a business as exists. The dividend is significantly higher when judged on five-year rolling bases.The twenty-year earnings per share growth rate is 10.5%. It’s one of those rare purchases where adding a stock can improve both the quality and growth characteristics of your portfolio.