Hershey's Beats EPS; Boosts View

Chocolate maker, The Hershey Company ( HSY - Analyst Report ) posted second quarter 2012 adjusted earnings of 66 cents a share, beating the Zacks Consensus Estimate of 61 cents by 8%. Also, earnings rose 17.9% from the prior-year quarter, driven by revenue growth and improved gross margins in spite of rising input costs and a difficult macro-economic environment.

Quarter in Detail

Hershey’s net sales of $1.41 billion rose 6.7% from the prior-year quarter, mainly buoyed by increased pricing. Benefits from pricing (6.6 percentage points) and the January 2012 acquisition of Canadian confectionary company Brookside Foods (2.4 points) were partially offset by volume declines (1.1 points) and foreign exchange headwinds (1.2 points). Quarterly sales however barely missed the Zacks Consensus Revenue Estimate of $1.42 billion.

Hershey’s is one of the largest U.S. confectioners and is well known for chocolate products 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’s adjusted gross margin for the quarter expanded 170 basis points (bps) to 44.8%, as pricing and productivity benefits and improved efficiencies from supply chain initiatives offset headwinds from rising input costs.

Selling, marketing and administrative expenses (SM&A), excluding advertising, increased at a mid-teens rate in the second quarter of 2012 due to increased investments in marketing in both the U.S. and internationally. Advertising spend increased 10% over the prior-year quarter as the company continued with its aggressive marketing efforts for established as well as newly launched brands worldwide. Operating margin expanded 40 bps in the quarter to 17.5%.

Outlook

For 2012, the company expects to record adjusted earnings in the range of $3.17–$3.23 per share, up from the prior forecast of $3.11–$3.17 per share on improved gross margins. The guidance mainly excludes acquisition/integration costs related to the Brookside acquisition and expenses related to Hershey’s supply chain and cost savings program, Project Next Century. Overall, adjusted earnings per share are expected to grow in the range of 12–14% year over year versus the prior expectation of growth in the range of 10–12%.

The 2012 net sales growth guidance (including the impact of foreign currency) was maintained at 7%-9%. The guidance includes a 1.5 percentage point benefit from the Brookside acquisition. Organic volume is expected to be up for 2012 as it accelerates in the second half of the year. Management expects price and volume to contribute in a more balanced manner for the rest of 2012.

For 2012, gross margins are expected to expand between 100–120 basis points year over year, up from prior expectations of an increase of 90–100 basis points. Expansion in gross margins will be on the back of pricing gains despite the higher input costs.

As previously guided, advertising expenses (as a percentage of revenue) are expected to increase in low double digits in 2012 as the company increases season-specific advertising, invests in core brand marketing, launches new products and supports the rollout of new brands like Jolly Rancher Crunch ‘N Chew candy, Ice Breakers Duo mints, Rolo Minis and Hershey’s Simple Pleasures chocolates. SM&A expenses, excluding advertising, are expected to rise in a mid-teens percentage for the remaining quarters of 2012, as the company expands internationally and invests in market research, category management, and building/selling capabilities.

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).

We are impressed by the company’s second quarter performance. Hershey’s strong brand positioning, strategic marketing investments in core brands, disciplined innovation, and consumer capabilities make it attractive. However, higher ingredient costs and lack of significant presence outside U.S. keep us on the sidelines.