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Hershey Beats Q3 Earnings, Misses Revs

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Renowned chocolate maker, The Hershey Company (HSY - Free Report) , announced mixed third-quarter results beating the Zacks Consensus Estimate for earnings but missing the same for revenues. Moreover, the company maintained its sales and earnings outlook for 2013 and introduced the financial guidance for 2014. Encouragingly, the company increased its long-term earnings guidance.

Hershey’s third-quarter 2013 adjusted earnings of $1.04 per share beat the Zacks Consensus Estimate of $1.01 by 2.9%. Earnings also rose 19.5% from the prior-year quarter as solid margins and lower taxes made up for a relatively softer revenue performance in the quarter.

The adjusted earnings mainly exclude acquisition/integration costs and pension costs and expenses related to Hershey’s supply chain and cost savings program – Project Next Century.

Revenues and Volume Growth

Hershey’s third-quarter net sales of $1.85 billion rose 6.1% from the prior-year quarter, due to sales volume gains. The company’s quarterly sales, however, missed the Zacks Consensus Estimate of $1.88 billion.

Organically, the volumes grew 6.6 percentage points (pp). Volume added 6.1 ppto revenue growth driven by strong volume trends and market share gains of core brands like Hershey’s, Reese’s, Kit Kat and Ice Breakers. The improving volume trends of core brands in the U.S. were driven by increased advertising investments, consumer promotions and innovation.

New products in both the U.S. and overseas markets boosted top-line growth. Pricing added 0.5 pp to top-line growth. Currency hurt revenues by 0.5 pp, worse than a slight positive impact in the last quarter.

Hershey has been consistently gaining market share in all major channels of the U.S. CMG (chocolate, mint and gum) category. These channels include food, drug, mass merchandisers including Wal-Mart Stores, Inc. (WMT - Free Report) , and convenience stores. For the 12 weeks ended October 5, 2013, Hershey’s market share in these channels grew 0.7 share points year over year driven by core brand growth.

Margins Go Up

Hershey’s adjusted gross margin for the quarter expanded 300 basis points (bps) to 46.2%, driven by lower input costs, productivity gains, improved efficiencies from supply chain initiatives, favorable mix and better fixed cost leverage.

Excluding advertising, selling, marketing and administrative, expenses (SM&A) increased 12% in the third quarter of 2013. The SM&A increase was much below management’s expectations of a 20% increase. Accordingly, these expenses are expected to increase meaningfully in the next quarter.

Advertising spend increased 22% over the prior-year quarter to support core brands as well as new products in both the U.S. and international markets. Despite higher advertising costs, operating margin improved 100 bps in the quarter to 20.3% mainly due to solid gross margin expansion.

The company continuously invests in advertising and marketing capabilities to build its brands globally. The company’s brand investments give it a competitive advantage and are one of the principal reasons behind the company witnessing better volume elasticity versus its peers.

2013 Outlook Maintained

Hershey continues to expect 2013 net sales to increase about 7% (including foreign exchange impact) which is at the higher end of its long-term target range of 5%–7%. Though the third-quarter revenues were slightly soft, management expects sales to pick up in the fourth quarter gaining from the confectionery holiday season. Management aims to achieve the target on the back of core brand volume growth, innovation, heavy promotion and merchandising and international expansion.

Gross margins are expected to expand by 240 bps to 250 bps in 2013 up from prior expectations of 220 bps to 230 bps, driven by input cost deflation, higher productivity and greater fixed cost leverage.

Advertising expenses (as a percentage of revenues) are expected to increase 22%–23% in 2013, higher than prior expectations of a 20% rise to support core brands as well as product launches in both the U.S. and international markets.

The company maintained its adjusted earnings guidance in a range of $3.68–$3.71 per share. The adjusted earnings guidance represents 14% year-over-year growth as the expected increase in advertising and SM&A expenses are expected to be offset by the higher gross margin and lower taxes. Full-year tax rate is expected to be about 34.5%, lower than prior expectation of 35.0%.

Introduced 2014 Outlook

In 2014, the company expects to post adjusted earnings in the range of $4.01–$4.12, in line with the new long-term earnings growth target of 9%–11%. Previously, the company expected its long-term adjusted earnings per share to increase in the range of 8%–10%.

2014 net sales are expected to be within the long-term targets of a growth in the range of 5%-7%. Hershey’s international sales are expected to grow in double digits in the year helped by acquisitions and joint ventures.

Other Stocks to Consider

Hershey carries a Zacks Rank #3 (Hold). Hershey’s strong brand positioning, strategic marketing investments in core brands, disciplined innovation and consumer capabilities make it attractive.

Other stocks in the food industry that are currently performing well include The J. M. Smucker Co. (SJM - Free Report) and Treehouse Foods, Inc. (THS - Free Report) . Both the companies carry a Zacks Rank #2 (Buy).

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