From the list provided yesterday, it's clear as a baby's complexion that Hershey has some of the best branded goodies in the U.S. candy biz. That isn't in question. Other items are. Today we peer under the hood to see how strong the Hershey river runs, and how high it might rise. While looking, we'll compare the Chocolate King to our three contenders so far: Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP), and chew boy Wrigley (NYSE: WWY).
First, some basics.
At its recent price of $52, Hershey has a market capitalization (diluted shares outstanding multiplied by share price) of $7.3 billion, which is one billion less than Wrigley. Hershey, like Wrigley, has existed for over a century. (When you consider that it took these companies 100 years to reach approximately $8 billion in value, the feats of Intel, AOL, Microsoft, Amazon, eBay, and others -- if valuations hold -- are all the more fantastic. In the cases of Amazon and eBay, the rapid creation of value is partially thanks to the network effect of the Internet. Never before has global reach been so quickly attainable.) Hershey's enterprise value, however, is significantly different from its $7.3 market cap due to its debt.
Enterprise value adds debt and subtracts cash from market cap to determine a company's sales value, or what an acquirer would pay for it. Hershey holds $31.7 million in cash and $1.2 billion in long-term debt and other long-term liabilities. This places its enterprise value at $8.5 billion. With $4.4 billion in revenue last year, the company's enterprise value is 1.9 times past sales.
Time to compare key performance results at Hershey to the other companies we're learning about.
KO PEP WWY HSY
ROE 35.0% 31.7% 28.4% 47.6%
ROIC 31.2% 23.0% 24.5% 25.7%
Gross Margin 70.4% 57.3% 57.7% 44.4%
Oper. Margin 26.4% 12.9% 20.6% 18.2%
Share Price $54 $34 $72 $52
Div. Yield 1.1% 1.6% 1.2% 1.9%
(The sub-2% dividend yield across the board for these behemoth companies is not the norm.)The table above shows Hershey in front regarding return on equity -- however, Hershey has enough leverage to impact this, while Wrigley has none. Gross margin and operating margin are led by Coca-Cola, with Wrigley second and Hershey last. Although market-wide, Hershey's numbers are excellent, it is not the most respected company in terms of operating efficiency. Margins have not risen notably for about a decade, and Hershey's book value is flat with 10 years ago. Wrigley and Coca-Cola, meanwhile, have grown book value almost every year over the past decade.
Time for some valuation and balance sheet comparisons.
KO PEP WWY HSY
Price/Sales 7.0 2.2 4.1 1.7
Price/Book 14.7 7.1 5.4 7.1
Price/$Flow 34.1 14.1 23.8 11.2
P/E on '99 EPS 41.5 27.9 26.4 24.6
LT Debt/Equity 0.12 0.38 0.00 0.85
(For Foolish education on the performance measures in the tables above and on valuing stocks, please see the Fool's "How to Value Stocks.") Hershey is the least expensive stock on a price-to-sales and enterprise value measure, as well as on a price-to-cash flow and P/E measure, but not on price-to-book value. The least expensive there is Wrigley. Hershey's debt level is significant, but isn't cause for meaningful concern. As shown above, Hershey's gross margin is considerably below peers (by 13 points, at 44%), but its profitability measures are still far above average. The average public company generates profit margins in the 7% range, and the average company in America in the 2% to 3% range, so Hershey's business is significantly above that. It is a solid operation, if not increasingly efficient.
How fast can the business grow? The industry is already immense and grows very slowly. The U.S. Department of Commerce Census Bureau reports that 1997's per capita consumption of confectionery products reached an all-time high of 26.7 pounds per person in the United States. All-time high, great! But this represents a mere 0.8% per person increase over 1996. Excluding gum products, per capita consumption rose to 24.9 pounds per person on 1997, a 1.2% increase over 1996. That's not much better.
The Department of Commerce shares that the average American consumer buys 11.7 pounds of chocolate candy, 12.3 pounds of non-chocolate candy, and 1.8 pounds of gum daily. Er, annually. (Daily in Brian's case.) Chocolate per capita consumption rose 0.3% in 1997, while non-chocolate per capita consumption grew 1.7%, and gum showed a 5.2% decline. (Wrigley did well anyway, growing internationally.)
Given its mature industry, Hershey (much like Wrigley) can grow best domestically by using some of its pricing power and by capturing market share from competitors. (The problem with new products is they sometimes take market share from one's own products.) If you're like me, you noticed that good old Hershey chocolate bars have risen from a quarter apiece to over 50 cents since the 1980s. Some of this is inflation, but much of it is pricing power. The competitors tend to raise prices in lockstep (surely there's no collusion), steadily, much like the soda industry.
Another potential growth avenue is new markets -- specifically international markets. Hershey sells products in over 90 countries, but Mars and Nestle lead it in nearly all of them. Hershey has done so poorly internationally that international sales account for only 4% of its revenue. Even Canada and Mexico have flopped. The company is on record saying that international markets will be difficult to crack, in part because tastes differ. Beyond sales growth, Hershey can improve its performance through acquisitions and cost-cutting, but these are typically finite roads to travel. Hershey is steadily traveling all these roads: new products, cost savings, acquiring leading brands, international markets, some pricing power. Yet, it has grown at a market-losing pace since 1991, and this is one of the strongest North American economies in history.
It makes me wonder. Without an apparent new strategy in place to grow earnings at least 11% annually, Hershey may fall in rank in the industry and its valuation may continue to contract. The past 10 years, the stock has lost to the S&P 500 by a smidge. Seven percent EPS growth over the past five years, and 8% since 1991, simply doesn't cut it. Plus, these results are even lower when you factor in the share buybacks that helped mask slow (about 5%) net income growth.
Tomorrow, guest Nelson E. Timken from the message board ("FoolishFinancier") chimes in, and on Friday Brian will share his thoughts on Hershey. Maybe he can change my mind. (For fodder before then, see this excellent and recent Hershey Dueling Fools.) As much as I enjoy Hershey's products and respect its U.S. business, my vote is to drop it from the list because we have goals that are more aggressive than its past 10-year results. Our long-term desired rate of return is nearly double Hershey's EPS growth this decade. To discuss this column, please visit the Drip Companies board.
