At first taste, you may be inclined to say, "No, siree, Bob. Not gonna happen with Hershey. Can't be done. Nope. That's the straight dope."
The company is on track to grow earnings per share (EPS) only 8% annually since 1991. Over the past five years, Hershey has grown sales only 4.9% annually, EPS 7.3% annually, and its dividend 10% per year. Possibility for significant improvement always exists (for instance, a giant chocolate-loving race could descend on us from outer space), but it doesn't appear that vastly improved results will solidify for Hershey anytime soon.
Last week, Hershey announced that third quarter results will miss expectations and disappoint investors. Management blamed summer investments in software and infrastructure for missed shipments in August and this month, leading to the shortfall. The Fool's Warren Gump (I don't know why, but we call him "Forrest") covered the news. Forrest Gump summed up the situation succinctly:
"Hershey has dominant domestic brands and, relative to the market, its stock has a low valuation. While these characteristics can be attractive from an investing point, a third characteristic -- growth opportunities -- are not obvious. The company's domestic market seems fairly mature with nominal growth and it hasn't been successful in international and expansion endeavors. Unless something changes and the company finds ventures to boost its growth rate, you can probably find better places to put your money."
Now, relative to the market and to peers, Hershey's valuation to its EPS is indeed melting. When we first looked at Hershey on December 9, 1997 (and if you've been with us that long, congratulations -- you have seniority over Brian!), the stock traded at 27.6 times trailing 12-month earnings and 26.9 times the year's EPS estimate. At the time, Hershey was expected to grow EPS 12% annually the next five years. This was a heady figure given the company's recent lackluster performance. Expectations have since melted to 9.5% growth per year, still aggressive given the past five year's 7% growth. This year, EPS growth will likely be nil (down 9%). Given this, the stock has melted.
At $52, Hershey trades at 15.4 times trailing earnings, which is nearly half the P/E that it commanded less than two years ago. The P/E contraction isn't nearly all due to share price depreciation, however. In each of the past two quarters, Hershey has experienced significant one-time gains from the sale of its pasta unit (mama mia!) and from a change in its retirement medical plan, both of which boosted EPS and lowered the P/E. The P/E isn't so low on forward estimates, however. The stock stands at 24.6 times the 1999 consensus estimate and 20.9 times year 2000 estimates. This compares to industry average forward P/E multiples of 23.5 and 20, respectively.
Hello? Value? Where is the value? Value was just here, I thought.
So did many investors, all the way down. The stock is 30% below its 52-week high, but even now it may still only represent modest value when the company's growth potential is poured into an analytical mold. A premier company like Hershey deserves a modest premium over industry peers, but even at this price the stock's recipe needs more sugar to make the valuation interesting. Of course, the company is in the right business for sweetness.
Hershey's bread and butter are chocolate, confections, and all manner of sweet treats. Founded in the late 19th century, the company is #1 in its niche. It competes heartily with Mars and Nestle for continued dominance. A real-world Willy Wonka Factory, Hershey's major products include Hershey's Kisses, Hershey's Cookies & Creme bars, Hershey's Hugs, Amazin' Fruit gummy bears, Cadbury's Creme Eggs, Caramello candy bars, Kit Kat wafer bars....
Wait. Take a deep breath. Okay. Continue.
... Luden's throat lozenges, Mr. Goodbar candy bars, Almond Joy and Mounds candy bars, Reese's Peanut Butter Cups, Reese's Pieces (E.T. loves 'em), Rolo caramels, Skor toffee, Symphony chocolate bars, Twizzlers, York peppermint patties....
Stop. Wait. Breathe again. We don't want to lose readers to oxygen-depravation. After all, we already lost Brian to psychosis. Okay. Ready? Please continue again.
... 5th Avenue candy bars, Jolly Rancher, Milk Duds, Whoppers, Payday, Sweet Sensations, TasteTations, and Pot of Gold. The company also uses the Hershey's brand to sell baking chips, drink boxes, cocoa, chocolate milk, syrup, ice cream toppings and peanut butter, among a few other products. To focus on candied goodies, Hershey sold its 8 pasta brands this year for $450 million.
Hershey has tres, tres impressive North American distribution (try to find any gas station, rest area, drug store, or home that does not have Hershey products). Over 2 million North American retailers carry its leading brands, while internationally Hershey exports sugared-goodies to over 90 countries. However, for the most part, the international strategy has proven tasteless. A mere 4% of Hershey's sales occur outside the United States.
There is no question that Hershey is the premier company when it comes to selling confectionaries in the United States. It is. Therefore, the quality of the business will likely continue to reward patient, long-term owners. Will the reward be enough for us and our goal?
Tomorrow we'll consider some key numbers to see how potent Hershey's business is compared to other purveyors of sweetness, namely Coca-Cola, PepsiCo, and Wrigley. To discuss these companies, please visit the Drip Companies message board. Now go grab yourself a Chocolate Kiss and say goodnight.