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Margins Hurt Hershey's 4Q Earnings

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Renowned chocolate maker, The Hershey Company’s (HSY - Free Report) fourth quarter 2012 adjusted earnings of 74 cents a share missed the Zacks Consensus Estimate of 75 cents by a penny. Top-line growth was offset by operating margin declines and rising advertising expenses, thus causing the earnings miss. Earnings, however, rose 5.7% from the prior-year quarter.

The adjusted earnings mainly exclude acquisition/integration costs related to the Brookside acquisition, pension costs, impairment charges related to the investment in a Colorado company, and expenses related to Hershey’s supply chain and cost savings program, Project Next Century.

Interestingly, the company raised its full year 2013 earnings outlook as it expects to gain from lower input costs and other cost savings.

Quarter in Detail

Hershey’s net sales of $1.75 billion rose 11.7% from the prior-year quarter driven by volume growth, which was boosted by holiday-driven spending. Volume added 7.0 percentage points to revenue growth, significantly better than last quarter’s 2.1 percentage point; in line with management expectations of posting sequentially better volume growth in the quarter.

Pricing added 2.3 percentage points. Currency benefited revenues by 0.3 percentage points, much better than the negative impact seen in the last few quarters. The Jan 2012 acquisition of Canadian confectionary company, Brookside Foods benefited revenue by 2.1 percentage points. Quarterly sales also beat the Zacks Consensus Revenue Estimate of $1.71 billion.

The company is consistently gaining market share in core U.S. retail channels. For the 12 weeks ended Dec 29, 2012, Hershey’s U.S. CMG (Candy, Mint, Gum) retail takeaway in channels, which account for over 90% of the U.S retail business, grew 7.0% year over year. The market share in these channels grew 1.2 share points over the same timeframe. These channels include food, drug, mass merchandisers including Wal-Mart Stores, Inc. (WMT - Free Report) , and convenience stores.

Hershey’s adjusted gross margin for the quarter expanded 140 basis points (bps) to 43.1%, as pricing and productivity benefits and improved efficiencies from supply chain initiatives offset the headwinds from rising input costs.

Excluding advertising, selling, marketing and administrative expenses (SM&A) increased 19% in the fourth quarter of 2012. The SM&A increase was higher than management’s expectations due to increased investments in marketing capabilities in both the U.S. and internationally.

Advertising spend increased substantially by 27% over the prior-year quarter as the company continued with its aggressive marketing efforts for both new as well as established brands. Operating margin declined 60 bps in the quarter to 15.8% due to higher SM&A and advertising costs. Last quarter, the company had already announced plans for an additional advertising investment in the fourth quarter.

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.

Annual Results

In fiscal 2012, the company witnessed a 9.3% increase in revenues to $6.6 billion, in line with the Zacks Consensus Estimate. The net sales growth rate marginally beat the company’s expectations of an improvement in the range of 8%–9%.

Adjusted earnings were $3.24 per share, which were in line with the Zacks Consensus Estimate and also near the higher end of the company’s guidance range of $3.22–$3.25. Earnings increased 14.5% from the prior year.

2013 Outlook Updated

The company maintained its outlook for net sales growth to be within its long-term targets of 5%–7%. Volume growth of core brands driven by the increased promotional efforts; increased innovation; and introduction of Brookside brand products in core retail channels in U.S. are expected to help Hershey achieve its sales targets.

Gross margins are expected to expand in 2013 by 180–200 basis points as input cost inflation subsides. Productivity gains and costs savings will also boost margins.

The company expects SM&A expenses to increase in fiscal 2013, at a higher rate than net sales. Advertising expenses (as a percentage of revenue) are expected to increase 20% year over year in fiscal 2013, mainly to support the Brookside product launch, new product launches in both U.S. and internationally, and increased promotional efforts for the Hershey’s brand in China.

The company upped its adjusted earnings guidance to a range of $3.56–$3.63 from the prior expectation of $3.48–$3.58. The adjusted earnings guidance represents growth range of 10%–12% year over year, higher than the prior expectation of growth in the range of 8%–10%.

Investments in core brand marketing, regular product innovation, productivity improvement and moderate commodity cost inflation are expected to help it achieve these targets despite a challenging macroeconomic environment.

Other Stocks to Consider

Hershey’s carries a Zacks Rank #3 (Hold).Some consumer staples companies that are currently doing well and have a bright outlook include ConAgra Foods, Inc. (CAG - Free Report) and Kellogg Company (K - Free Report) . Both the companies have a Zacks Rank #2 (Buy).

In-Depth Zacks Research for the Tickers Above

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Kellogg Company (K) - free report >>

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