Investors had been optimistic heading into Hershey's (HSY -2.69%) third-quarter earnings report. Through mid-October, the stock roughly doubled the 20% gain in the wider market in 2019 thanks to encouraging signs of firming demand trends and rising profitability. Yet this optimism pushed shares to a rich valuation that could only be supported by positive earnings momentum.
Last week, Hershey gave bullish investors some good news on the profit margin front that could protect the stock's recent rally. At the same time, however, the company has some work to do in recapturing its prior market-thumping sales growth rate.
Let's take a closer look.
Sweet and salty
The recent acquisition of the One Brands franchise helped lift sales higher by almost 3%, but on an organic basis revenue inched up by 1.6%. That's essentially even with last quarter's modest expansion pace and reflects sluggish growth in some key markets.
Looking behind the top-line figure, a few trends stand out. Hershey got another big boost from the salty snack brands it brought under its umbrella by purchasing the Amplify and Pirate franchises. The core candy portfolio didn't perform as well, with sales volumes declining slightly in the U.S. market thanks to the pressure added by Hershey's latest price increases.
Yet the consumer staples giant gained market share both at home and in the international segment while meeting management's global targets. "We are pleased with our results and the momentum we are seeing in our core business," CEO Michele Buck said in a press release.
Spending and outlook
The price increases and the demand shift toward high-margin salty snacks helped push gross margin up to 45% of sales from 44% a year ago. All of those gains were offset by extra spending on advertising, though, and so adjusted operating profit grew at a slower pace than sales, rising to $477 million compared to $470 million. Operating margin dipped slightly to 22% of sales while the company placed its bets on initiatives that should drive improving market share in 2020 and beyond. "This [spending] increase is in line with expectations," CFO Steve Voskuil said in a conference call with investors, "as we prioritize reinvesting gross margin expansion gains back into our brands to drive growth."
The latest trends gave Buck and her team enough confidence to affirm a full-year outlook that calls for organic sales to grow about 1.5%. That's a significant slowdown from 2018's 4% increase, but it still translates into market share gains even in the context of rising prices. Hershey sees adjusted earnings climbing as much as 7% this year.
Management said the purchase of nutrition bar specialist One Brands fits right into Hershey's broader snacking ambitions and will help reported sales rise by an extra percentage point in 2019. Beyond that, investors are hoping to see the combination of rising profitability and the integration of new salty snack products push demand back toward the 4% organic increase Hershey managed last year. If things go according to that ambitious plan, the confectioner could begin posting double-digit earnings growth as early as 2020.