Here's Why The Hershey Company Is a Wonderful Business

In Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) 2011 letter to shareholders, Warren Buffett wrote, "'Buy commodities, sell brands' has long been a formula for business success." Hershey  (NYSE: HSY  ) has followed that formula for years: buying sugar and cocoa and selling Hershey's, Reese's, Kit Kat, and other American favorites in the candy aisle.

Buffett explains how good Hershey's business is in a 1991 speech at Notre Dame:

If you walk into a drugstore, and you say 'I'd like a Hershey bar' and the man says 'I don't have any Hershey bars, but I've got this unmarked chocolate bar, and it's a nickel cheaper than a Hershey bar,' you just go across the street and buy a Hershey bar. That is a good business.

When people buy chocolate, they do not buy the cheapest brand. They buy the best brand. It does not matter how many knock-offs are on the shelf next to it; most people who want a chocolate bar are going to buy a Hershey's bar.

But do not take my word for it, look at the data: Hershey has the leading share of its core market.

Source: The Hershey Company

The only company that comes close to matching Hershey in the U.S. is Mars -- the company that Berkshire Hathaway helped to finance in the 2008 acquisition of Wrigley. But even Mars has just a 30% share of the U.S. chocolate market compared to Hershey's 44% share.

Wrigley, in which Berkshire Hathaway maintains a minority interest, has an overwhelming 58% share of the U.S. gum market -- a market that Hershey largely ignores. Moreover, Wrigley generates most of its sales outside of the U.S., making it less of a threat to Hershey.

Mars and Nestle (ADR) (NASDAQOTH: NSRGY  ) are Hershey's primary competitive threats in the United States, where Hershey generates close to 85% of its sales. Though private labels are unable to attract a significant following among brand-conscious consumers, other brands offer substitutes. For instance, Mars's M&Ms may be substituted for Reese's Pieces.

Nestle is launching a direct competitor to Reese's Peanut Butter Cups. Just about the only thing that can compete with a well-known American brand is another well-known American brand.

Nestle's Butterfinger Peanut Butter Cups will be available in stores starting January 2014 and will be featured in a Super Bowl commercial in February. According to a Nestle spokesperson, it will be the first time that Nestle USA has run a Super Bowl commercial -- signaling that the company is planning to mount a significant challenge to Reese's cups.

But even if Nestle adds to its measly 6% share of the U.S. chocolate market via its Butterfinger Cups roll-out, it is unlikely that Americans will ditch Reese's Cups en masse; the Reese's Cups brand has too much mind share for consumers to suddenly start buying another brand. This is part of what makes Hershey a wonderful business -- its combination of sugar and cocoa can sell at a higher price than Nestle's combination simply because of the branding.

Long-term value creation
Due to its enormous market share and leading brands, Hershey earns higher returns on invested capital, or ROIC, than most businesses. If you divide the company's after-tax operating profit by its average invested capital, you find that the company earns an ROIC in excess of 15% on average.

Source: Hershey

This means that for each dollar Hershey invests in expanding or maintaining its business, the company earns more than $0.15 in after-tax profits each year. If you earned a 15% after-tax return on your stock portfolio each year, you would be pretty happy with the results. That is essentially what Hershey earns -- and that's why it is a wonderful business.

Moreover, Hershey compounds the effect by continually lowering its share count. Although the company has not repurchased a significant number of shares since the financial crisis, the long-term trend shows that Hershey is devoted to reducing the share count over time.

Source: Hershey 

The combination of high returns on invested capital and shareholder-friendly management has enriched shareholders over the last two decades.

HSY Chart

Hershey data by YCharts

Bottom line
Hershey has a leading (and growing) share of the U.S. chocolate market; its portfolio of brands is more popular among Americans than any other company's brands. This enables it to charge higher prices than competitors, which in turn enables it to earn high returns on invested capital.

Hershey is not untouchable. Nestle and Mars can compete with it in many markets within the United States. Even much smaller companies, like Berkshire Hathaway's See's Candies, have a larger share of select markets than Hershey.

But Hershey will continue to earn out-sized profits as long as Americans care more about the brand they buy than the price of the sugar-and-cocoa combination. This has held true in the 119 years since Hershey opened its doors, and there is little reason to believe it will not be true for the next 119 years.

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Read/Post Comments (8) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On December 03, 2013, at 3:32 PM, BradReeseCom wrote:

    Hi Ted,

    You state:

    "Moreover, Hershey compounds the effect by continually lowering its share count. Although the company has not repurchased a significant number of shares since the financial crisis, the long-term trend shows that Hershey is devoted to reducing the share count over time."

    Well, the Milton Hershey School Trust (Hershey's controlling shareholder because of its Class B Hershey stock, 10 votes per share) continues to sell Hershey common shares in an ongoing effort to diversify its investment portfolio. But heck that PESKY Hershey stock keeps going up in value (because of the success of the H.B. Reese Candy Company) so that in reality, the VALUE of the Hershey Trust portfolio is still overweighted in Hershey stock.

    The joke among Wall Street investment bankers is that The Hershey Company is NOTHING MORE than the H.B. Reese Candy Company doing business as (DBA) The Hershey Company.

    For example, according to Advertising Age and Euromonitor International, the Reese's Brand was the #1 ranked candy brand in the United States with 2012 sales of $2.603 BILLION. Reese's was the #4 ranked candy brand globally with 2012 sales of $2.679 BILLION. That's right, Reese's was ranked #4 globally with just a mere $76 million of its sales OUTSIDE the United States.

    The Hershey's Brand did NOT even make the Advertising Age/Euromonitor International list as a top candy brand either globally or even in the United States.

    Furthermore, the non-union H.B. Reese Candy Company manufactures the Kit Kat for the U.S. market, Kit Kat had 2012 U.S. sales of $948 million making it the #4 ranked candy brand in the United States according to Advertising Age and Euromonitor International.

    Finally on Facebook, the Reese's Brand has "4 times" the number of United States fans than the Hershey's Brand.

    In other words, without the H.B. Reese Candy Company, the stock market value of The Hershey Company would only be several billion, not the $21 billion it is today.

    Sincerely,

    Brad Reese

  • Report this Comment On December 03, 2013, at 3:45 PM, mazske wrote:

    Mr. Reese,

    According to the Hershey website, Reese was sold to Hershey in 1963. It appears Mr. Reese benefited from Mr. Hershey way back when. Sure, Reese has helped Hershey to become the company it is, however, after 50 years, I think Hershey's is the company, not Reese.

    Respectfully,

    mazske

  • Report this Comment On December 03, 2013, at 5:55 PM, BradReeseCom wrote:

    Hi mazske,

    You bring up a very good point about Hershey's website, it continues to promote misleading as well as very inaccurate information about the H.B. Reese Candy Company and the success of the Reese's Brand.

    Reese was NOT sold to Hershey.

    On July 2, 1963, 7-years after my grandfather H.B. Reese's death in May 1956, my father Charles Richard Reese and his 5-brothers (Bob, John, Ed, Ralph and H.B. Reese, Jr.) merged the H.B. Reese Candy Company with the Hershey Chocolate Corporation in a tax free stock-for-stock merger.

    With the 6 Reese Brothers receiving 666,316 shares of Hershey common stock valued in 1963 at $23.5 million.

    After the 1963 merger, the Reese Brothers owned such a large portion of Hershey's Public Float, they were restricted by an investment letter from selling any Hershey shares.

    Over the past 50-years Hershey's stock has split so many times, the original 666,316 Hershey shares owned by the 6 Reese Brothers now represent 16 million Hershey shares.

    That represents more than $31 million per year in cash dividends (i.e. $85,000 in cash per day to the Reese Family every single day of the 365 days of the year).

    And guess what, next year that will increase by at least another $8,500 per day with the next dividend increase.

    Mazske, if you want to understand WHY The Hershey Company continually FAILS to acquire other Family Owned Candy Companies, look NO further than how Hershey has treated the legacy of my grandfather, H.B. Reese.

    2013 was the 90th anniversary of the founding of the H.B. Reese Candy Company and the 50th anniversary of the Reese/Hershey STOCK-FOR-STOCK MERGER.

    And NOT A PEEP was mentioned by Hershey of these 2 anniversaries.

    Family owned candy companies which are the acquisition targets of The Hershey Company WILL NOT allow the legacy of their great candy companies to be demolished the way The Hershey Company has demolished the great legacy of my grandfather, H.B. Reese.

    And that mazske, has cost Hershey shareholders untold billions in new Hershey shareholder wealth.

    Sincerely,

    Brad Reese

  • Report this Comment On December 03, 2013, at 6:39 PM, mazske wrote:

    Mr. Reese,

    You should be very proud of your grandfather.

    I'd love to offer comments on your comments, however, to do so, I think I would be much better able to do so if I could do one thing.

    Do you know if any of the merger paperwork is available to be studied?

    Thank you,

    mazske

  • Report this Comment On December 03, 2013, at 7:40 PM, mazske wrote:

    Mr. Reese,

    Your family has practiced a key principle that the Fool teaches. This is buy quality companies and hold for years and years.

    Do you mind if I share your comments about how the original 666,000 shares turned into 23 million shares over 50 years?

    I will share it on a Stock Advisor board if that is OK.

    Thank you,

    mazske

  • Report this Comment On December 03, 2013, at 7:59 PM, BradReeseCom wrote:

    Hi mazske,

    Here's a draft copy of the original July 2, 1963 H.B. Reese Candy Company merger agenda with the Hershey Chocolate Corporation:

    http://www.bradreese.com/blog/hb-reese-candy-co-hershey-choc...

    Here's the history of Hershey stock splits:

    http://www.thehersheycompany.com/investors/stock-information...

    You have my permission to share the July 2, 1963 Reese/Hershey merger agenda, I mean, that's why I'm making it public to set the record straight as unfortunately, The Hershey Company, continues to constantly mislead and provide inaccurate information about the legacy of my grandfather, H.B. Reese.

    If Hershey shareholders only knew how costly this has been for Hershey shareholder wealth creation because FAMILY OWNED CANDY COMPANIES will NOT SELL or MERGE with Hershey because of what Hershey has done to demolish the legacy of my grandfather, H.B. Reese

    I mean, my Dad and Uncles were already rich in 1963 and making yearly incomes that dwarfed those of the top executives at Hershey.

    Additionally, prior to the 1963 merger, Reese sales DOUBLED EVERY 4 YEARS.

    Hershey shareholders ONLY have the wealth they have today because the H.B. Reese Candy Company continues to kick butt and take names!

    Sincerely,

    Brad Reese

  • Report this Comment On December 03, 2013, at 8:58 PM, mazske wrote:

    Mr. Reese,

    I've dug around a bit and have found various posts you have made. In one, on the seeking alpha website, you said in your opinion, the Hershey Company should be renamed the H.B. Reese's Candy Company.

    Well, if you truly believe that, this is what you should think about doing.

    Your family is quite wealthy. So, why don't you start buying up as much HSY stock that you can? If you can get enough, maybe the day will come that you can have the company renamed.

    If you can get more shares, that will help you with your agenda more than your various posts will.

    It's just a thought.

    Take care and stay positive,

    mazske

  • Report this Comment On December 03, 2013, at 10:53 PM, BradReeseCom wrote:

    Hi Mazske,

    My cousin Robert Reese was about to accomplish a once in a lifetime opportunity for Hershey shareholder wealth creation when he was betrayed:

    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a...

    The knives are long and sharp in Hershey, PA.

    Sincerely,

    Brad Reese

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