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The Hershey Company (HSY - Analyst Report) posted first quarter 2012 adjusted earnings of 96 cents a share, handsomely beating the Zacks Consensus Estimate of 81 cents. Also, earnings jumped 31.5% from the prior-year quarter, driven by solid revenues and improved margins despite rising input costs and a difficult macro-economic environment.

Quarter in Detail

Hershey’s net sales of $1.7 billion rose 10.7% from the prior-year quarter, mainly buoyed by increased pricing. Benefits from pricing (10.9 percentage points) ) and the January 2012 acquisition of Canadian confectionary company, Brookside Foods (0.7 points) were partially offset by volume declines (0.5 points) and foreign exchange headwinds (0.4 points).

However, decline in volume was significantly lower than company expectations due to a solid Easter season. Quarterly sales also beat the Zacks Consensus Revenue Estimate of $1.66 billion.

Hershey’s adjusted gross margin for the quarter expanded 180 basis points (bps) to 44.2%, as pricing and productivity benefits and improved efficiencies from supply chain initiatives offset headwinds from rising input costs. Unlike Hershey, rising input costs and volume declines have crippled most food companies, leading to margin declines despite improvement in revenues.

Advertising spend increased 14% over the prior-year quarter as the company continues with its aggressive marketing efforts for established as well as newly launched brands, both in U.S. and internationally.

Operating margin expanded 290 bps in the quarter to 21.3%, fueled by declines in other selling, marketing and administrative (SM&A) expenses, which offset headwinds from increased advertising costs.

In the quarter, the company repurchased shares worth $125 million against last year’s repurchase authorization of $250 million.

Outlook

For 2012, the company expects to record adjusted earnings in the range of $3.11-$3.17 per share. The guidance mainly excludes the acquisition/integration costs related to the Brookside acquisition and expenses related to Hershey’s supply chain and cost savings program, Project Next Century.

Management continues to expect its total adjusted pre-tax charges and non-recurring project implementation costs related to the Project Next Century program to be $150 million to $160 million for 2012. Overall, adjusted earnings per share are expected to grow in the range of 10-12% year over year versus prior expectations of a growth in the range of 9-11%.

The 2012 net sales growth guidance (including the impact of foreign currency) was raised from a range of 6.5-8.5% to 7-9%. The new guidance however includes expected revenues of $90 million from the Brookside acquisition. Organic volume is expected to be up slightly for 2012.

For 2012, gross margins are expected to expand between 90-100 basis points from 2011 levels, also up from prior expectations of an increase of about 75 basis points. The gross margin increase is despite expectations of higher input costs in 2012 versus 2011 to be driven by cost savings and pricing gains.

As previously guided, advertising expenses (as a percentage of revenue) are expected to increase in low-double digits in 2012 as the company invests in core brand marketing, launches new products and conducts advertising campaigns for some recently launched brands like Jolly Rancher and Rolo.

Our Recommendation

We currently have a Neutral recommendation on The Hershey Company. The stock carries a Zacks #3 Rank in the near term (Hold rating).

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