Chocolate giant The Hershey Co. (NYSE:HSY) took a big bite out of the pretzel market on Nov. 10 with its announced acquisition of two major pretzel makers, Pretzels Inc and Dot's Pretzels LLC. Buying out the two producers of the classic loopy, crunchy pastries will cost Hershey about $1.2 billion. The move is costly, but it may be the right choice at the right time to build on the success already visible in the company's recent Q3 results, with the potential to keep the bullish momentum going into the future.

The details of the pretzel buyout

The double-pretzel deal makes the biggest Hershey acquisition since 2017, when the snack producer bought out SkinnyPop popcorn maker Amplify Snack Brands for $1.6 billion in cash. However, Hershey's corporate history shows a steady drumbeat of acquisitions across time, showing this is an established part of its operational strategy, likely with robust mechanisms in place for assessing potential buys.

According to Hershey's press release, CEO Michele Buck expects the buyout to "further accelerate our success in the permissible salty snack category," citing gains made by the Pirate's Booty and aforementioned SkinnyPop brands in support. Buck says Dot's Pretzels' seasonings give it strong product differentiation and popularity, claiming Dot's sales "[represent] 55 percent of the pretzel category's growth during the past year."

A cheerful-looking person in a yellow jacket holding a large pretzel.

Image source: Getty Images.

The other acquisition targets Pretzels Inc., currently owned by a subsidiary of private investment firm Peak Rock Capital. A look at Peak Rock's news page shows it regularly acquires and sells companies, including many food sector enterprises, so its divestiture of Pretzels Inc. shouldn't indicate any financial problems with the brand.

Hershey says it's buying Pretzels Inc. primarily to obtain its three pretzel factories, which Hershey will use to expand production of Dot's Pretzels. It notes the buyout will gain it "deep pretzel category and product expertise and the manufacturing capabilities to support Dot's growth and future pretzel innovation," meaning the two acquisitions are synergistic.

Hershey will fund the buyout with a mix of cash and loans, saying it expects the acquisitions to be accretive to adjusted earnings per share (EPS) next year and to GAAP EPS in 2023. It notes both acquired companies together generated about $275 million in revenue over the past 12 months. However, viewing this through the lens of Hershey's plans to use Pretzels Inc.'s facilities to make Dot's brand pretzels, which have a very high sales growth rate, future revenue gains may well be higher than the past results, which are likely limited by Pretzels Inc.'s more sedate rate of growth.

Putting the acquisition in context with Hershey's Q3 results

Hershey's Q3 2021 metrics, reported on Oct. 28, provide some sweet, chocolaty goodness for shareholders to chew on. Its quarterly revenue rose 6.3% year over year, while adjusted earnings per share (EPS) surged 12.9% compared to Q3 2020. Both volume and prices rose for the quarter, though volume was limited by the supply chain problems plaguing the entire economy in the wake of COVID-19 lockdowns.

Hershey also boosted its full-year 2021 guidance, raising its original 6% to 8% sales growth to 8% to 9%, as well as adjusted EPS to be 11% to 13% higher than fiscal 2020 rather than its earlier 8% to 10% prediction.

Hershey's results look solidly positive, but at least one major analysis firm is sounding a cautionary note about its prospects. With more than 17% gains over the past year, Citibank analyst Wendy Nicholson claims the chocolate company is now at a bull run peak. Dropping its rating to Neutral on Oct. 29, she expects growth to slow in 2022 despite noting the Hershey "is one of the most structurally advantaged and most well-run companies in the U.S. packaged food space" and describing it as "one of the best-performing stocks in our food coverage universe."

This assessment, of course, couldn't take Hershey's two pretzel company acquisitions into account. Boding well for future revenue generation by its new subsidiaries, its two major salty snacks brands performed superbly during Q3, with sales of Pirate's Booty puffed snacks surging 27% and SkinnyPop popcorn sales growing 23.3% year over year.

Overall growth in the pretzel market overall is fairly modest, with a 2.7% compound annual growth rate (CAGR) expected through 2026, according to Mordor Intelligence research, with increasing craft beer consumption and diabetes patients looking for healthier snacks being major drivers.

However, Hershey and Dot's Pretzels both claim Dot's has significant market share and rapid sales increases -- growth that is likely to be accelerated by Hershey's distribution network, paired with the additional production capacity of Pretzels Inc.

With growth ongoing, and as a dividend stock to boot, Hershey stands out among food stocks for its current and likely future performance. While there is some risk its advance will level out or sag as Citi predicts, its pretzel strategy looks to have a good chance of helping it keep the positive momentum going in the coming year. Therefore, Hershey is probably still a buy right now.

 
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.