Hershey (NYSE:HSY) may not be a sure thing strictly speaking, but there aren't many companies out there with its history of consistent revenue and dividend growth. International growth is still a valid talking point, as is valuation, but Hershey looks like one of the better volume growth stories in the food sector right now.
Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.
Fourth Quarter Results Fueled by Volume and Ads
Hershey had an interesting fourth quarter from a financial perspective. Revenue rose 12% as reported, whereas most investors were looking for 9% growth (including the Brookside deal). Volume jumped 7%, well ahead of expectations of 2-3% growth, and pricing improved over 2%. That makes Hershey one of the strongest volume growth stories in food right now, and perhaps a leading indicator that shoppers have adjusted to years of price resets.
Margins were more mixed. Gross margin improved almost a point and a half, and it beat the expected target by about a half-point. Operating income was not as impressive - rising (adjusted) about 8% (against an 11% target), while operating margin fell 60 basis points (BPS) and missed analyst expectations by a full point. Looking closer, Hershey spent aggressively on advertising, and that boosted volume growth while compressing margins.
SEE: Analyzing Operating Margins
Leveraging Lower Input Costs into Sales, Through Marketing
As part of the fiscal cliff compromise, legislation was passed that prevented what could have been a sharp spike in dairy prices. With that, Hershey is looking at pretty tame input costs for 2013, which should give the company more leverage on gross margin. Instead of letting that drop through to the bottom line, however, it sounds like the company will direct it toward greater ad spending.
On balance, this sounds like a good idea. About 78% of Hershey's brands get ad support, and increasing ad support in the recent past has led to disproportionate sales growth, so it seems like a good use of funds. What's more, rivals like Mars, Mondelez (Nasdaq:MDLZ) and Nestle (OTC:NSRGY) have been pretty aggressive recently in both new product introductions and ad support, so Hershey needs to keep pace.
International Opportunities Still a Talking Point
Hershey is one of the strongest confection companies in North America, with Mars and Hershey together holding nearly 60% of the market (with close to equal shares). As has often been pointed out, though, Hershey has some of the lowest international and emerging-market exposure of the North American food companies, and this limits the company's long-term growth.
Although it's a small part of the total, Hershey's international business has been growing (up 12% this quarter, including currency) and could be around 15% of sales quite soon. That should give investors some confidence that Hershey can build a more global business over time.
SEE: An Evaluation Of Emerging Markets
I still wish management would consider more aggressive actions to position Hershey better overseas. Ferrero and Perfetti Van Melle would both be interesting properties, either of which could significantly improve the company's distribution in emerging markets. I realize that the ownership of the Hershey Trust significantly restricts management's options (particularly since the Trust's priority/preference is for stable, safe income streams), but I can nevertheless hope that the Trust might see the long-term advantages in such a move.
The Bottom Line
Investors are often willing to pay premiums for strong brands like Hershey and Coca-Cola (NYSE:KO), and these shares rarely get cheap in an absolute fundamental sense. Nevertheless, I still think Hershey is a little expensive today. A long-term revenue growth forecast of between 5 and 6% and generous assumptions about future free cash flow (FCF) conversion support low double-digit potential FCF growth, but that doesn't point to a fair value much above today's price.
Relative valuation doesn't help much either. Buying these shares at a relative P/E ratio of less than 1.2 has always worked out before for long-term investors, but today's 1.4 relative P/E ratio is on the high end of the range. As a result, even the strong volume growth and high ongoing returns on capital at Hershey don't lead me to want to buy the shares today.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
Stock AnalysisA summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
Options & FuturesInvesting during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
Investing BasicsHeld onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
EconomicsWill remaining calm and staying long present significant risks to your investment health?
Stock AnalysisIs DKS a bargain here?
Investing NewsA third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
Stock AnalysisHome Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
Stock AnalysisYelp investors have had reason to be happy recently. Will the good spirits last?
Stock AnalysisWalmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
Stock AnalysisAs a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>