Investment Thesis
The well-known chocolate company Hershey has been concentrating on its core domestic brands while lowering its global footprint. With more than one-third of the US chocolate market, the company maintains its dominant position despite the possible negative effects of consumers' demand for confections due to financial constraints. The management of Hershey's is making long-term investments by expanding its supply chain, increasing digital capabilities, and building capacity. Over the last five years, capital expenditures have averaged close to 6% of sales, which is roughly 150 basis points higher than what is anticipated for the company over the long run. Hershey is using price hikes, price/pack changes, and efficiency enhancements to reduce profitability in spite of cost pressures.The company's innovation pipeline, which grew by over 40% in fiscal 2024 over the prior year, demonstrates its dedication to allocating resources to its brands. According to projections, Hershey allocates approximately 7% of its annual sales, or more than $900 million, to marketing, R&D, and other initiatives that they believe are wise investments.
Investment Upsides
Given its dominant market share in the US confectionery industry, Hershey's cost advantage and intangible assets give it a strong economic moat rating. Since 2015, the company's namesake, Reese's, and the top US chocolate brand, which currently commands nearly 18% of the market, have helped it gain almost 500 basis points of market share. This demonstrates that consumers, especially when they want to indulge, prefer to stick with reliable brands and are unwilling to compromise taste. Instead of using unproven suppliers who might not have the resources to meet supply chain demands, retailers would prefer to stock well-known brands that can increase foot traffic to their stores. After acquiring Amplify (Skinny Pop), Pirate Brands, and Dot's, Hershey's made the wise decision to diversify its product line to include more popular categories like wholesome snacks. This is because these products cater to consumers' desires for convenient and healthful food. The market share increases that these acquired brands have been able to achieve are a result of Hershey's strong brand, retail connections, and extensive resources.
Due to its cost advantage, Hershey should be able to finance investments to support its dominant brand mix and retail relationships more than new competitors with tighter budgets. Advantages in production and distribution throughout its vast network are a result of this scale. Compared to its smaller competitors, Hershey has lower unit and distribution costs, a more efficient supply chain, and a better capacity to leverage brand spending. Because of this, Hershey is able to imitate rival products and eventually sell them to retailers for less than its smaller competitors. This may restrict the amount of shelf space (and scale) that new competitors can acquire.Hershey boasts above-average direct operating margins (33% versus 26%) in comparison to the rest of the packaged food coverage universe, despite inconsistent disclosures. Returns on invested capital, including goodwill, have continuously outperformed our 7% weighted average cost of capital estimate by three to four times, averaging 24.5% over the last five years, providing more proof of the company's strong competitive position. In support of our position on the firm's broad economic moat, I predict that ROICs will average in the low-20s over the next ten years.
I consider the impact of anti-obesity medications to be minimal, despite the fact that there is still a lot of worry about how they may affect consumer demand for Hershey's decadent snacking and confectionery offerings. In more specific terms, I believe that Hershey's extensive resources and abundance of data and analytics should allow it to adjust its portfolio in order to skillfully match its mix with changing consumer trends, making any volume hit minimal. There are also concerns about whether retail relationships will have the same influence online, especially in the snacking industry where small, specialized startups fiercely compete for market share and impulsive purchases are common. Given that consumers spend three-fourths of their online search time on retailer websites, Hershey has been collaborating with its retail partners to integrate its online and offline strategies. Hershey's innovation efforts have included full-size bar variety packs to appeal to online indulgers and impulse buyers, as well as updated packaging to appeal to online shoppers. As a result of these efforts, average selling prices on the internet have increased to about 1-4 times the level that Hershey receives across its portfolio in physical stores. Management emphasized that it is not giving up on helping retailers increase foot traffic in physical stores, which I believe is wise given our expectations that an omnichannel strategy will best meet the changing needs of customers.
Valuation
Investment Downsides
Environmental, social, and governance concerns, as well as macro and competitive forces, all have an impact on Hershey's risk profile. If customers choose healthier options, its financial performance may suffer, and local governments may raise taxes or regulations to combat obesity. Human rights concerns in its supply chain and Hershey's reliance on West African cocoa could put the company's reputation at risk and result in more government scrutiny. ESG hazards are minimal. Hershey's profits may occasionally be impacted by variable input costs, especially those related to dairy, sugar, and cocoa. Long-term, rising demand for raw materials in developing nations could keep commodity prices high and have an effect on earnings. Other confectionery companies and snack options outside of the confectionery aisle are competitors of Hershey's. Chocolate's less established culture, premium pricing, economic uncertainty, inflation, and trade shutdowns brought on by the Covid pandemic exacerbate structural issues outside of its home country. The gloom surrounding shopping excursions, foodservice operations, and travel retail endures despite market closures.
Guru Activity
It is probably one of the rarest occasions where Gurus have got the timing of the market wrong. This is because from the above chart we can see that Gurus hopped into this opportunity just when cocoa prices commenced to soar. And we know how sensitive Hershey's overall cost structure is to cocoa prices.
Additionally, some of the most notable long/short hedge funds have taken long positions on Hershey's.This send out an encouraging signal to the investors.We can also see some prominent hedge funds like Holocene who has added Hersheys shares worth $142 million to their portfolio for the very first time
Portfolio Management
Hershey is fairly valued at the moment and investors who want a slice of consumer discretionary in their portfolio in midst of tech sellof can consider this stock.Hershey's dominance in the US confectionery industry is attributed to its cost advantage and intangible assets. Since 2015, its Reese's and top US chocolate brand have helped it gain nearly 500 basis points of market share. This demonstrates consumers' preference for reliable brands and a preference for wholesome snacks. Hershey's acquisitions of Amplify, Pirate Brands, and Dot's have allowed it to diversify its product line and increase market share. The company's cost advantage allows it to finance investments more than new competitors with tighter budgets, resulting in lower unit and distribution costs, a more efficient supply chain, and better capacity to leverage brand spending. Hershey's direct operating margins are above-average, and its returns on invested capital have consistently outperformed the 7% weighted average cost of capital estimate by three to four times over the last five years. Hershey's extensive resources and data and analytics allow it to adjust its portfolio to match changing consumer trends.
