On Monday, US candy-maker Hershey Foods (HSY) updated investors on its plans to achieve global growth over the next five years. The firm will target annual revenue growth of 5-7% and annual earnings per share growth of 8-10%. Hershey's will focus on its five core brands, which are Hershey's, Reese's, Hershey's Kisses, Jolly Rancher and Ice Breakers. The company hopes these cornerstone brands will propel annual sales to $10 billion by the end of 2017. Hershey's thinks new supply-chain initiatives will yield $50 million to $80 million in annual cost savings. We think these targets could be lofty and that shares of Hershey are currently overvalued (click here for our valuation reports).
Specifically, we think the company will struggle to fight against the obesity and sugar backlash in the United States. Low-fat and low-carbohydrate diets seem to go in and out of style the US, and right now, low-carbs-specifically low sugar-diets are en vogue. This could create a long-term shift away from consuming chocolate and other products with large amounts of sugar. Additionally, New York City Mayor Michael Bloomberg recently started a war on soda over a certain size and thus a certain amount of sugar. We think more cities could follow-suit in creating anti-sugar legislation as a way to curb higher obesity rates and healthcare costs. If blue-chip US companies like Coca-Cola (KO) and Pepsi (PEP) are under attack, we certainly do not think a smaller company like Hershey is immune. Lifestyle changes and legislation will likely be powerful headwinds in the company's path.
Further, we think commodity input prices may fluctuate tremendously over the next several months-possibly years. Though we generally believe these movements may eventually balance themselves out over the long-term via higher pricing and cost-cutting measures, the movements may obscure the true earnings potential of the company and reduce investor confidence (particularly if a firm misses earnings due to higher input costs in any one period). We think this could translate into a volatile share price. Identifying the most timely exit and entry points on the most undervalued stocks is why technical and momentum indicators remain core to our stock-selection process, the Valuentum Buying Index.
Although Hershey has been able to successfully introduce smaller-sized portions and packages to adapt to a shift in consumer food consumption habits, we still think the company will be challenged going forward. Rising obesity rates and healthcare costs could make candy manufactures a target of legislation and societal scapegoats. Though we do think Hershey is a great value creator (its return on invested capital continues to be greater than its cost of capital), we think shares are overvalued at current levels. Given a paltry 2.2% annual dividend yield, we also do not think the firm is a very attractive dividend growth investment. We'd stay on the sidelines regarding Hershey until its valuation became significantly more compelling.