The Hershey Company: Chocolate With An Attitude

| About: The Hershey (HSY)
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Sometimes, we make investing so much harder than it has to be. I believe we complicate the process in order to flatter ourselves. We are tempted to invest in companies that do things we don't understand so we can feel smart. We want to believe investing is akin to rocket science, and in order for a person to succeed at it, he or she must be brilliant. Nothing is further from the truth, and I was reminded of that fact the other day when I was standing in the grocery store check out line. While waiting for the person ahead of me to pay for his items, I grabbed a couple of York Peppermint Patties to munch on. York Peppermint Patties are part of the Hershey Chocolate Company (NYSE:HSY) family. My research began with the first bite. Investing is simple, and occasionally it can be quite tasty, so get yourself a Hershey Bar to nibble on and join me in a perusal of the candy maker.

$10,000 put to work in Hershey stock five years ago has grown to over $25,000 today. For those of you who prefer percentages, that's an annual return of 21%, far outstripping the 6% put up by the S&P 500.

HSY has paid uninterrupted dividends since 1930 and currently distributes $1.68 a share for a yield of 1.94%. The company's payout ratio stands at 60%.

Trading at $86.50, the company sports of a lofty PE of nearly 30. This generous valuation is on the high side of the company's historic PE parameters. The confectioner's earnings next year are estimated to come in at $4.01 a share, deflating the PE to a somewhat more reasonable 21 times earnings.

The fact that people love chocolate, and the fact that such love creates torrents of cash flow, probably accounts for Hershey's apparent ease at carrying large loads of debt. Over the last five years, HSY's long-term debt has been in the vicinity of $1.5 billion.

In 2008, privately held Mars bought Wrigley's Gum, making Mars the largest candy maker in the world. Hershey has never gotten over it and has vowed to surpass Mars in North American sales. To accomplish this, HSY plans to grow revenues primarily through acquisitions. 2012 saw the company begin its shopping spree with the purchase of Brookside Foods, a privately held Canadian confectioner. After conquering the Americas, Hershey has plans to turn China into its second-largest market and is also casting covetous glances India's way. The candy maker's goal is to inflate revenues to $10 billion in five years. This is a 50% increase over last year's numbers. It's an ambitious goal to say the least.

Hershey Chocolate faces formidable adversaries in the war to capture the world's sweet tooth. In addition to the above-mentioned Mars, two that come to mind are Mondelez International (NASDAQ:MDLZ) and Nestle (OTCPK:NSRGY). All three companies lay claim to powerful arsenals.

Some of the arrows in the Modelez quiver are Oreo, Nabisco, Cadbury branded chocolates and Trident gum.

Among the host of products Nestle sells, the three most likely to offer Hershey the most competition are the Butterfinger, Crunch and Wonka brands.

It would seem that Mars is the most worthy of HSY's opponents. Its stable of brands includes M&Ms, Snickers, Mars Bar, Twix, Three Musketeers, Skittles and Orbit gum.

To face this impressive group of competitors, Hershey counters with a truly staggering portfolio of goodies. Here are just a few of the treats offered by the company. We'll start with the ubiquitous Hershey Chocolate Bar, and then continue on to Almond Joy, Mounds, Hershey Kisses, Kit Kat, Reese's Peanut Butter Cups, Whoppers, York Peppermint Pattie (my personal favorite), Rolo, Milk Duds and Carefree Sugarless Gum.

As I cited earlier, HSY is striving for $10 billion in sales in the next few years. I think it will make that number and I base that conviction on one simple word, attitude. Please allow me to make my case.

If you look at Nestle, you see a behemoth involved not only in the confectionery business, but also one engaged in the production and sale of everything from bottled water to pet food. Nestle peddles baby food, breakfast cereal, frozen prepared foods, instant soups, coffee, tea, seasonings, dairy products and life insurance. Yes, you read correctly, life insurance. If you'll remember, Nestle acquired Gerber in 2007. Nestle now sells Gerber Life Insurance. I believe that Nestle, successful as it is, can't possibly concentrate with the same intensity as can HSY when it comes to the purveying of sweets. The fact that in 2002, Nestle made a multi-billion dollar bid for Hershey is what I consider a affirmation of that belief.

Modelez, just spun off from Kraft foods, appears to be a bit dizzy. The company's latest quarterly report talks of disappointing sales, structural changes and key personnel desertions that can and most times do become major distractions. Distractions are an unconscionable waste of time, energy and resources. These are assets better spent on new product development, promotion and brand building. Mendelez certainly has a global presence, but the fact that its products list rivals Nestle's in length and variety, convinces me that its attention is as diffused as Nestle.

There are a few financial ratios I would like to show you between Nestle and Hershey. Because these comparisons are in a five-year context, I'm omitting Mondelez. Here goes.

As mentioned earlier, HSY stock's annualized five-year return is 21%. Nestle's return is 10%.

As far as profitability is concerned, Hershey's ROI is 21.25%. Nestle comes in at 17.38%. Hershey's operating margin is 17.18%. Nestle trails at 14.39%

Moving on to some growth metrics, Hershey's five-year EPS growth rate is 25.45%. Nestle sits at 8.16%. Revenue growth, Hershey 6.08% and Nestle 1.09%. Cash flow growth, Hershey 15.68% and Nestle 4.07%.

To be fair, Hershey carries much more debt than Nestle, but with an interest coverage ratio of 11.4, HSY shouldn't have any problems keeping the bank happy.

Nestle and Modelez are like skilled jugglers keeping all the plates in the air. They are both doing it well, but there is only so much you can handle until you break a plate.

And finally, we come to the privately held and deliciously secretive Mars. Mars isn't obligated to disclose any financial information, but I'm sure its annual sales total many billions of dollars. Its stable of products is just as extensive as either Nestle or Mondelez, but I have a suspicion that chocolate remains its true love. Chocolate, after all, is where Mars got its start, so I doubt that management would tolerate any neglect of its confectionery division.

Aside from the selling of candy, the corporate cultures of the two companies couldn't be more different. Mars is tight-lipped and almost monastic in its dealings with the public. Hershey is a public company that shares information and wealth with its stockholders. Forrest Mars, son of company founder Frank Mars, was so tight-fisted that his two sons never tasted an M&M when they were growing up. Forrest told them he couldn't spare even one M&M for them to sample. In contrast, Hershey's founder Milton spent his fortune building a utopian town for his workers. He also opened a school and an orphanage.

Corporate dichotomy notwithstanding, I believe Hershey will more than hold its own with Mars. If the 2012 fourth-quarter and fiscal-year results are any indication, the company has a good start on reaching its goals. Hershey strikes me as being more committed than Mars. There's a sense of pride that seems to come through in Hershey's public statements. It has the attitude of a scrappy underdog and I love that. Come to think of it, so does America.

Let me know what you think.


Disclosure: I 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.