This Company Will Make a Killing in 2014

Hershey (NYSE: HSY  ) will increase earnings and sales in 2014 by selling innovative new products to meet the growing demand for chocolate in North America while strategically building its business in Asia.

In North America -- where Hershey is the market leader -- cocoa-bean grindings rose by 4.4% in the fourth quarter, Reuters reported. For all of 2013, North American cocoa grindings rose 7.5%  to 509,237 tons from 2012, the fastest pace of growth in three years.

Hershey's international revenue -- excluding Canada -- will top $1 billion in 2014 -- a year sooner than previously expected. For a company with a total of $7 billion in sales, the upside potential for international sales is huge. Hershey recently announced plans to buy an 80% interest in Shanghai Golden Monkey Food Joint Stock Co. for about $584 million. Hershey gains new distribution channels and popular local candies including Golden Monkey honey-peach hard candies, cheese chews, and seaweed water sticks. The takeover will add to Hershey's earnings in 2014. Hershey will also open a new chocolate factory in Malaysia in 2015.

"Outside the U.S. and Canada, we expect that our international business will be up about 15% this year (2013), putting us on track to achieve about $1 billion in net sales by the end of 2014," John P. Bilbrey, Hershey president and CEO, told investors during the company's third-quarter conference call.

 

Innovation
For many years Hershey depended on its popular brand name and pricing power to achieve earnings growth. In more recent years, the company has aggressively created new products such as its York Minis, Lancaster Soft Creams Caramels, and chocolate spreads to compete with Nutella. Other products that are gaining traction are Rolo Minis, Kisses Deluxe, and Kit Kat Minis. The company's Brookside Foods acquisition added chocolate-covered fruit to Hershey's rich portfolio of products.

Another impressive move is Hershey's alliance with 3D Systems to come up with innovative ways to use 3D printing technology to create edible foods, including confectionery treats. I'm not sure this will add significantly in the short term, but this could be a $1 billion business some day as bakers, entrepreneurs, and home-cooking lovers design their own candies.

Valuation and competition
It's hard to find companies exactly like Hershey. Mondelez International (NASDAQ: MDLZ  ) sells Cadbury Chocolates and Trident Gum, but it also sells Oreos, Tang, and Jacobs coffee. The forward P/E for Mondelez is 22.5, cheaper than Hershey's 26.5 forward P/E.

Mondelez's dividend yield of about 1.6% lags Hershey's 2% yield, while Mondelez's market cap is $61.8 billion compared to Hershey's $22 billion. Mondelez gets 19.6% of its revenue from North America while Hershey gets 83% of its sales from the USA. Mondelez already is a big-time player in the international markets, more like Nestle the Swiss food giant, whose market cap is $237 billion. Hershey is small in comparison and gives long-term investors much more upside, especially with international sales.

The way I came to invest in candy companies was in the early 1990s when I met Pete Valonis, owner of the Candy Kitchen in Grand Island, Neb., who told me to buy stock in Wrigley and never sell it. The stock traded around 27 times earnings, which critics viewed as a high multiple. The company paid a 1.3% dividend while my shares of the stock grew around 15% annually. In 2008, Mars bought Wrigley for $23 billion -- a multiple of 32 times projected 2008 earnings. That 32 P/E is much higher than Hershey's forward P/E of 26.5.

Some critics compare Hershey to a bond that yields 2%, but Hershey has raised its dividend 51% over the past five years.

Risks going forward
Critics say Hershey should pursue more sustainable and ethical purchases of cocoa.  Forced child labor is used in some African plantations. If Hershey decides to replace its current West African supply chain due to fair trade concerns, it could face logistical issues and higher costs. Hershey announced in 2012 that it plans to source 100% "certified" cocoa by 2020, but didn't use the word fair trade. Hershey's new factory in Malaysia is where cocoa has been growing commercially since 1853.

If costs go up, and surely they will, Hershey is in good shape because the average price of a Hershey candy bar is around $1.50. The company could raise prices and probably not lose any volume.

Final Foolish thoughts
It's tough to predict where the stock market will go in 2014, so investors must stay with winning stocks that achieve real growth in sales and earnings. Innovation is helping Hershey build on its dominant position in North America while strategic investments like the Golden Monkey acquisition and new factory in Malaysia will boost international sales. Hershey plans to grow its international sales to 20% of total sales by 2017.

This year Hershey management expects total sales to grow 5% to 7% and earnings 9% to 11%. Even if the stock remains flat, I'm happy to accept its steady dividends, but it's possible rising earnings may cause Hershey's stock price to reach sweeter highs.

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