Hershey: Needs Aggressive Efforts To Fuel Long-Term Growth

| About: The Hershey (HSY)
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Summary

Company needs to alter its product portfolio by introducing new products consistent with healthy consumer eating habits.

Company can fuel its near-term earnings growth by improving its cost structure.

Stock is trading at a forward P/E of 24x, versus its peers average forward P/E of 21x.

The Hershey Company (NYSE:HSY) is among the leading U.S. confectionery companies. The company holds a dominant market share of almost 30% in the U.S. confectionery market. Despite the company's strong product portfolio, the company has struggled in the recent years to grow its sales volume consistently, because of a shift in consumer preferences towards healthy snacking alternatives. As a result of changes in consumer demands, confectionery category growth has slowed to almost 1.5% from last five years average of 3%. Also, the company has been slow to respond to changing consumer demands, and most of its new product launches in 2015 failed to deliver desired results. I believe the company needs to alter its product portfolio by concentrating on healthy alternatives, and it should increase its advertisement and marketing activities to support revenue growth. Also, the company can fuel its near-term earnings growth by improving its cost structure. The stock has historically traded at premium valuations to its peers because of its high-profit margins and strong market share; however, I believe valuation premium will narrow until business fundamentals and revenue growth improve.

Financial Performance and Growth Catalysts

The company delivered mixed financial results for 2Q16. HSY reported EPS of $0.85 for the quarter, ahead of consensus estimate of $0.79. Also, revenues for the quarter grew by 3.7% YoY. The performance for the quarter was positively affected by pull-forward of sales from 3Q to 2Q because of merchandising timing. The management of the company lowered its revenue growth target by 0.5%, and now expects total revenue growth of 2% for 2016 on constant currency basis. Moreover, EPS for 2016 is expected to be in a range of $4.24-$4.28, representing a growth of 3%-4% YoY.

The company has been facing challenges to grow its sales volume on a consistent basis as a result of a shift in consumer preferences towards healthy snacks. Also, intense competition in the industry has weighed on its revenue growth. HSY has struggled and has been slow to adapt to changing consumer preferences. Also, most of the company's new product launches in the recent quarters failed to gain traction, mainly because they were not consistent with changing consumer demands. I believe the company has scale and expertise to fuel its revenue growth by making aggressive efforts to alter its product portfolio by concentrating on healthy snacks. Also, this will allow the company to get more shelf space, which will augur well for its revenue growth; some retailers in the U.S. are offering less shelf space to confectionery products because of a shift in consumer demand towards healthy alternatives.

The company has taken some correct measures by acquiring BarkThins and Krave, consistent with consumers demand for healthier protein-rich snacks. These acquisitions will positively affect the company performance in the upcoming quarters, but the acquisitions of these small brands in healthy snacks category will not have a significant impact on HSY's performance in the near-term. As HSY has the financial muscle, it should look for bigger strategic acquisitions to strengthen its product portfolio and support its revenue growth.

Also, the company needs to focus more on its international markets to fuel growth. In the recent quarters, it has struggled in China, and it seems it will face more challenges in China as Chinese chocolate market growth remains weak; China experienced a 3% decline in chocolate sales in 2015. Also, Mondelez (NASDAQ:MDLZ) plans to enter the Chinese chocolate market by introducing Milka brand in September, which will increase competitive pressures for HSY.

Despite the ongoing challenges, the company has a potential to fuel its earnings growth by improving its cost structure and accelerating share buybacks. These measures will not only fuel top-line growth but will provide visibility to earnings growth, which will enhance investors' confidence. The company is targeting to achieve cost savings of $135 million in 2016, under its Continuous Improvement and Productivity (CIP) program. I think as the company has rejected MDLZ acquisition bid, HSY will now act with a greater sense of urgency to justify its decision to remain an independent entity; therefore, I believe the company will announce incremental cost savings. HSY has a potential to reduce its costs and expand margins to fuel EPS growth, as its overhead expenses as a percentage of revenues are almost 350bps higher than its competitors. I think, the company might update its cost saving targets at its upcoming investors day in October.

Summation

The company has been slow to alter its product portfolio according to changes in consumers' demand, which along with intense competition has put pressure on its revenue growth. The company needs to actively alter its product portfolio by introducing new products consistent with healthy consumer eating habits. Also, the company can fuel its near-term earnings growth by improving its cost structure, as it currently has high overhead expenses as compared to its peers. The stock has historically traded at almost 15% premium valuations to its peers; however, I think, the valuation premium will contract until business fundamentals improve. The stock is trading at a forward P/E of 24x, versus its peers average forward P/E of 21x.

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.