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We are bullish on The Hershey Company (HSY) because of its long-term expected top and bottom line growth rates of 5%-7% and 10%, respectively. It also offers an attractive ROE of 63%, above that of its competitors. Along with an attractive potential growth rate, it also offers a decent dividend yield of 2.1%. The company has strong brands, and is the market leader in the U.S. chocolate market. Based on the aforementioned reasons, we recommend buying the stock.

The Hershey Company is the largest quality chocolate producer in North America. It is also a global leader in sugar confectionery and chocolates. The company has operations around the world, with products being offered under more than 80 brands. Amongst its popular brands are Hershey's, Reese's and Kit Kat. It has annual net revenue of more than $6 billion. The company offers chocolate products, non-chocolate confectioneries, and pantry baking ingredients, toppings and beverages. The company has a market cap of almost $16.2 billion.

The company reported net sales of $1.41 billion in 2Q2012, up almost 7% YOY. The increase in revenues was mainly due to an increase in prices. Sales volume decreased by 1% in the quarter due to price increases. Currency headwinds reduced total net revenues for the quarter by more than 1%. In the most recent second quarter, it registered EPS of 59 cents, as compared to 56 cents in the corresponding period last year. Gross profit margin increased to 43.7% in 2Q2012, as compared to 42.6% in 2Q2011. Selling, marketing and administrative expenses for the quarter were 27% of sales, up 1% YOY. For the fiscal year 2012, the company is expected to experience a net sales growth of 7%-9%, including the potential foreign currency impact. Full year EPS are expected to increase by 10%-12% in 2012.

To improve upon its operations and to grow, the company has worked out a five-year strategic plan. The company has a net sales growth target of 5%-7%, and an earnings target of 8%-10%. The company will be investing in and expanding its five core brands, namely Hershey's Kisses, Hershey's, Reese's, Jolly Rancher and Ice Breaker. It is expected to achieve a net sales target of $10 billion by the end of 2017.

Despite volatile commodity prices over the years, the company has successfully increased its margins. The following table shows the improvements in its margins, from 2009 to 2011:

2009

2010

2011

2Q 2012

Gross profit Margin

38.9 %

42.6 %

41.7 %

44.8 %

EBIT Margin

14.4 %

16 %

17.4 %

17.5 %

Net Income Margin

8.2 %

9 %

10.3 %

10.7 %

Source: Hersheys.com and Qineqt's estimates.

The company has significant growth potential. The U.S. confectionery market was worth $19.3 billion in 2010; it grew, on average, at 2.9% in the last eight years. The chocolate segment grew by 3.5%, and non-chocolate by 2.5%. The Hershey Company forms 28.9% of the total U.S. confectionery market. It is the market leader in the U.S. chocolate confectionery market, with a 42.9% share.

It is focused on expanding its operations and asserting its presence in international markets like China and Mexico. In the last four years, the confectionery markets of China, Brazil, India and Mexico grew, on average, by 7.4%, 12.5%, 22.7% and 4%, respectively.

The company currently offers a decent dividend yield of 2.1%. It has increased its dividend over the years, from $0.2975 per quarter in 2008 to $0.38 per quarter in 2012. It has an operating cash flow yield of 3.8%, and a free cash flow yield of 2.25%. This reflects that the company will be able to maintain its dividends going forward. The company has a debt-to-equity of 180%, which is greater than the industry average. However, the debt level has been decreasing over the years. In 2007, its debt-to-equity was 360%, which is currently at half the percentage. It has a strong interest coverage ratio of almost 11x.

HSY

Kellogg Company (K)

General Mills, Inc. (GIS)

Kraft Foods Inc. (MDLZ)

H. J. Heinz Company (HNZ)

Forward P/E

20 x

14.5 x

14 x

17.5 x

15.2 x

PEG

2.3

2.4

2.15

1.35

2.3

ROE

63 %

51 %

22 %

-

33%

Source: Yahoo Finance and Qineqt's estimates.

The company's forward P/E of 20x is supported by its high growth rate of almost 10% for the next five years. The company has high return on equity of 63% as compared to its competitors.

Source: Hershey Company: An Impressive Mix Of Dividends And Growth