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Hershey Retained at Neutral

HSY

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We have maintained a Neutral rating on The Hershey Company (HSY - Analyst Report) following an impressive performance in the first quarter of 2012.

Hershey reported first quarter 2012 earnings of 96 cents, way above 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.  Net sales rose 10.7% from the prior-year quarter, mainly buoyed by increased pricing. Gross margin expanded 180 basis points as pricing and productivity benefits and improved efficiencies from the company’s supply chain initiatives offset headwinds from rising input costs. We are impressed by the company’s solid first quarter performance. The company also upped its guidance for fiscal 2012.

Moreover, the company’s strong brand positioning, strategic investments in core brands, disciplined innovation, and consumer capabilities make it attractive.

Hershey is the largest producer of quality chocolate in North America and markets some of the world’s leading brands which enjoy widespread consumer acceptance. The company is also a global leader in chocolate and sugar confectionery products, which is an attractive category as confectionery products are easily available, affordable and highly indulgent, thus making it almost recession resistant. The company is well known for chocolates like Hershey’s, Reese’s, and Kisses, as well as non-chocolate confectioneries, such as Jolly Rancher candy, Ice Breakers chewing gum, Breath Savers mints, and Bubble Yum bubble gum.

Hershey invests in core brand marketing, continuously launches new products and conducts advertising and promotional campaigns to stimulate sales. This has resulted in consistent growth that continues to outstrip the company’s long-term targets established in 2008. The company invests in advertising and marketing capabilities to build its brands globally and monitors the performance of its brands. The company’s strong brand investments give it a competitive advantage and are one of the principal reasons behind the company witnessing better volume elasticity and margin gains versus peers.

In an effort to boost long-term growth, management has embarked on several programs to divest low-margin brands, improve supply chain efficiencies and implement cost-reduction initiatives. These strategies have helped to keep at bay rising input costs and expand margins.

However, more than 80% of the company’s business is generated in the U.S. In 2011, only around 15% of net sales were generated outside U.S. In January 2010, Hershey’s competitor, Kraft Foods, Inc. , purchased Cadbury. This strategic acquisition opened up new sales channels for the company through the latter’s vast distribution networks in the developing markets of India, Brazil and Mexico. Kraft Foods’ solid presence outside U.S. has hurt Hershey’s international prospects significantly. Higher ingredient costs and a lack of significant presence outside U.S. keep us on the sidelines.

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