Hershey's Faces Cost Pressures, Yet Shares Jump (HSY)

Shares of Hershey's (HSY) are up 6% in the 4 months that have elapsed since we told investors to pass on the confection giant. Shares have run up because of the recent inflation scare, which has sent a pile of cash into "safe" stocks, like cereal and beverage plays. What's striking is that Hershey's is by no means a safe or defensive stock, at least not in the traditional sense.

Because HSY essentially makes candy, people assume that even a recession won't hurt the stock. If you're unemployed, you'll probably still shave, buy Kleenex and munch on Kit Kat bars -- or so the thinking goes. The problem, as we see it, is that Hershey's is deeply levered to commodity and raw material costs, such as the price of sugar and cocoa, resulting in a fractured bottom line.

The current valuation isn't doing much for us, either: At 27 x trailing 12 month EPS, Hershey is swapping hands at a premium to its historical 5 and 10 year P/E averages. On top of this, sales are growing less than 1% (market saturation; only 11% of sales are outside the US) and cost pressures have turned off a large portion of investors. Insiders are telling analysts that 2006 EPS will jump 9%, but at the current multiple, as well as the volatile raw material environment, we're simply not convinced that shares represent an attractive risk/reward.

HSY 1-yr chart: