As one of the largest confectionary companies in the world, The Hershey Company (NYSE:HSY) has almost always been an attractive opportunity for long-term investors. While shares of the business have a tendency to trade at very high multiples and offer only modest yields (around 2.5% today), investing in the stock and reinvesting dividends would have earned shareholders an annualized return of about 12.5% pre-tax. To put this in perspective, investing $10,000 into the business's stock over this time frame would have resulted in that wealth growing to about $344,944.24 without factoring in taxes. Moving forward, I believe similar returns are probable, but the company has one major issue I believe needs to be addressed in order for it to truly perform well.
A look at domestic and international markets
As of the time of this writing, management at Hershey estimates that the company's products take up an aggregate market share of around 31.3% in the U.S., making it a major player in the chocolate and confectionary market in this country. Sales in North America (the U.S. and Canada since U.S. data is not provided by itself) stands at $6.47 billion, up 4.3% from the $6.20 billion seen during the company's 2013 fiscal year.
This level of sales has been driven, in part, by increases in volume during 2014, but, as management increased prices recently adding 4.8% to sales without factoring in any other fluctuations, volume actually dropped during 2015, hitting the company's top line by 2.5%. Due to changes in the market, combined with pricing strategies and changes in demand driven by economic reasons, this kind of fluctuation is to be expected and is likely healthy for Hershey and its investors in the long run.
As a result of greater economies of scale and pricing changes that more than offset volume declines, profits in the company's North America segment have done very well. In 2015, segment operating profit stood at $2.07 billion, up a whopping 11.3% from two years earlier when Hershey's segment operating profit stood at just $1.86 billion. What this means is that, over this period of time, the company's segment profit margin has risen from 30% of sales to 32.1%. I don't know about you, but I'd say that's a nice improvement in two short years and is at a level that is enviable in most industries.
The picture abroad, on the other hand, is anything but great. Despite seeing sales rise from $946 million in its International segment in 2013 to $1.07 billion in 2014, the segment's top line took a beating in 2015, falling to $918.5 million for the year. This was driven mostly by pressure in China, a country where the business has an estimated 10% market share in for chocolate alone and it's likely that this decline (which was 11% for the year) will be temporary and, in the long run, sales abroad will probably continue to grow for decades to come.
This all looks good, and it seems as though Hershey is merely dealing with a bump in the road toward higher growth, but it's not the sales of the company's International segment that's bothering me - it's Hershey's bottom line outside of North America. In 2015, the business, due to strong advertising and its drop in sales, reported a loss of $98.1 million, which implies a segment operating margin of -10.7%. Once sales rebound, the picture should improve and Hershey will likely be able to generate profits overseas down the road, but even with positive earnings, the company's results aren't impressive in the least bit.
You see, in 2014, when sales were meaningfully higher, Hershey saw a profit margin of only 3.7% with segment operating profits at $40 million. The year before, these numbers were 4.7% and $44.6 million, respectively. This disparity here is like light and day. In the U.S. and Canada, sales appear to be more stable and margins are extraordinarily high while elsewhere sales are subjected to a great deal of volatility while margins are downright awful.
Part of this, as I already mentioned, is due to advertising costs, which is pressuring profits as the business strives to snap up market share, but even this doesn't seem to be doing much. While many chocolate and non-chocolate confectionary companies were hurt in places like China last year, Hershey was hurt more than most, as evidenced by the fact that its market share in China contracted by 1.1% during 2015. This also suggests that competition is hammering the business, which could be attributed to any number of factors (differences in taste preferences, a sense of nationalism, prices, etc.).
Many years from now, I suspect that Hershey's sales and profits, on an absolute basis, will be materially higher than they are today, and some of this rise in sales will almost certainly come from its International segment. As the rest of the world becomes more developed, this may even open up the door for stronger profit margins but, in the meantime, this seems very much out of reach. The fact of the matter is that Hershey's bottom line overseas is far from impressive and the amount of time needed before this can become even somewhat comparable to the U.S. is probably quite a ways off.
This means, in my eyes, that management at Hershey may be operating in the best interests of shareholders by either spinning this segment off (even a partial segment so that they can still own some interest while allowing the segment to focus more intently on growth) or selling these operations to another party and allocating said capital toward further improving its business model here at home. Either of these could, I believe, have a higher probability of generating a strong return for shareholders years from now than the current path and any such move by the company to go this route should prove to be very bullish for long-term investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.