Hershey: Acquiring Iconic Nestle Brands Could Drive Growth (Raisinets, Anyone?)

| About: The Hershey (HSY)

Summary

The company has been on a strategic mission to drive revenue/earnings growth through adapting to changing consumer snacking trends and cost controls.

The company aims to improve its operating profit margins through supply chain optimization, a streamlined operating model and decreased administrative expenses.

We believe that the company will also drive revenue/earnings growth through acquisitions of innovative start-up snacking companies and/or product lines from larger companies.

Nestle’s possible divestiture of its U.S. confectionery business could be a growth driver for Hershey if the business is acquired at a value-oriented price.

An investor should buy the company’s shares on weakness to benefit from the company’s transformation to drive revenue/earnings growth through innovation/acquisitions.

Hershey (NYSE:HSY) has been on a strategic mission to drive revenue/earnings growth by adapting to changing consumer snacking trends and cost controls. In March 2017, the company announced that it would cut about 15 percent of its workforce as part of a cost-savings program to increase profit margins. At such time, the company reiterated its 2017 earnings estimates and identified its new cost-savings program by the name "Margin for Growth," which aims to improve its overall operating profit margin through supply chain optimization, a streamlined operating model and decreased administrative expenses, with savings primarily being achieved in 2018-19. The company also saw such program as providing flexibility and funds to deliver on its financial objectives. HSY anticipates that the program will result in total cumulative pre-tax charges of $375 million to $425 million. With such efforts, HSY is seeking the appropriate level of innovation, marketing plans and consumer and customer expertise to drive net sales growth, especially in its North America confectionery/snacks business. The is also making investments to grow its core confectionery business and expand its breadth by capturing new usage opportunities and participating in trending product categories.

HSY's "Margin for Growth" strategy should increase its efficiency, leverage global shared services and common processes and increase capacity utilization. The company expects cash savings to reach an annual run-rate of between $150 million to $175 million by the end of 2019. Over the long term, the company expects annual constant currency net sales growth of 2 percent to 4 percent, driven primarily by its North America business. Such long-term growth projection reflects changes in U.S. shopping habits and continued macroeconomic challenges impacting growth in international markets. In addition, given the scale advantages of HSY's North America business and the "Margin for Growth" related initiatives, the company expects to record long-term adjusted earnings per share-diluted growth of 6 percent to 8 percent. As HSY works to improve its margins and drive earnings growth, it will also adjust and innovate to adapt to changing consumer market trends. The company will also work to overcome adverse circumstances in the confectionery industry through internal innovation inside and outside the chocolate category and through acquisitions of smaller companies participating within higher growth chocolate and non-chocolate snack categories.

While HSY already has a stated plan to drive revenue/profit growth, we believe that the company has the option to drive revenue/earnings growth through acquisitions of smaller innovative start-up snacking companies and/or product lines from larger confectionery/snacking companies that have a strategic fit with HSY's strategy. With this in mind, Nestle SA's (OTCPK:NSRGY) recent announcement that it is exploring strategic options for its U.S. confectionery business (including a potential sale) could be a revenue/earnings growth driver for HSY if all or part of such business is acquired at an advantageous price. According to NSRGY, its confectionery business review only includes its U.S. confectionery business and it expects to complete such review by year end 2017. NSRGY's U.S. confectionery business recorded sales of about 900 million Swiss Francs in 2016 and includes well-known U.S. chocolate brands such as Butterfinger, BabyRuth, 100Grand, SkinnyCow, Raisinets, Chunky, OhHenry! and SnoCaps, in addition to sugar-based brands such as SweeTarts, LaffyTaffy, Nerds, FunDip and PixyStix. The strategic review does not cover NSRGY's Toll House baking products, a strategic growth brand which NSRGY will continue to develop. Further, NSRGY indicated that it remains fully committed to international confectionery growth, particularly its KitKat brand.

NSRGY's U.S. confectionery business represents about three percent of its U.S. sales. Although NSRGY is studying its exit from the U.S. confectionery business, it will continue to invest and grow in the U.S., where it has leadership positions across a large number of categories such as pet care, bottled water, frozen meals, infant food and ice cream. NSRGY will also continue to innovate across these categories to meet rapidly changing consumer demands. With NSRGY studying its exit from the U.S. confectionery market, where does this leave HSY? A follow up question would be, "Why is NSRGY thinking of leaving the U.S. confectionery market at all?" To answer the second question first, perhaps NSRGY anticipates greater growth in its non-U.S. confectionery businesses due to changing U.S. snacking trends. A cursory look at NSRGY's businesses shows it is a greatly diversified company far beyond confectionery products. Does this mean if HSY acquired some or all of NSRGY's U.S. confectionery businesses that it would be acquiring damaged goods? Not necessarily. With HSY much more focused on the U.S. confectionery market, its innovation, marketing and distribution network skills may be an asset to drive continued growth of an acquired NSRGY U.S. confectionery business. In addition, HSY's acquisition of NSRGY's chocolate related businesses may benefit from HSY's innovative, marketing and promotional acumen in the chocolate product category.

Our view

HSY continues to face weak sales growth due to adverse macroeconomic trends, changing consumer tastes and intense competition from the non-chocolate U.S. snacking products. The company's strong brand portfolio, innovation abilities along with its productivity and cost savings efforts, however, make it an attractive long-term investment. Near term, however, HSY will continue to experience weak sales growth, adverse currency effects and a consumer shift towards healthier snack options. Given changing snacking trends and consumers moving towards healthy snacking trends, HSY needs to be careful not to overspend on legacy brands that NSRGY may be offering for sale as noted above. With this in mind, HSY can benefit from selectively acquiring some of NSRGY's U.S. confectionery brands if such brands have potential to achieve growth in a snacking market where consumers are trending towards healthier snacks. With this in mind, HSY must careful not to acquire any NSRGY brands that are in slow decline. We should note that HSY is not alone in such shifting consumer preferences toward natural and organic ingredients instead of packaged and processed food. As consumers shift towards healthier snacks such as nuts, HSY is seeking growth through acquisitions of healthier snack food brands.

HSY's forward price-to-earnings ratio is about 23.25 based on 2017 earnings estimates of $4.81 and about 21.40 based on 2018 earnings estimates of $5.23. We should note that analysts have raised earnings estimates in recent months. HSY's shares have a 2.2 percent dividend yield. While HSY continues to face near-term pressures such as changing consumer preferences, adverse economic trends, adverse Chinese market circumstances and adverse currency effects, we believe that the company has the ability to meet the demands of changing consumer preferences and to offset adverse input costs. In addition, we believe that HSY will continue to make acquisitions of small startups to adapt to changing consumer snacking trends. Finally, as noted above, we see the company strongly considering the acquisition of parts of NSRGY's U.S. confectionery business to drive revenue/earnings growth. HSY also considers international expansion to be important as such new markets present new higher growth opportunities. Despite our long-term confidence in HSY, however, we recommend that investors wait until HSY's shares drop to the $98.05 to $103.30 range (a price-to-earnings ratio ranging from 18.75 to 19.75 based on fiscal year 2018 projected earnings) before investors initiate a position.

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Disclosure: I am/we are long HSY.

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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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