Shrinkflation Is the Trick in the Treat Bag

In this podcast, Motley Fool producer Ricky Mulvey and Motley Fool senior analyst Asit Sharma get in the Halloween spirit and discuss:

• Why candy is a growing market that's also shrinking.
• Hershey's M&A strategy and supply chain questions.
• Some Fools' Halloween candy rankings.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on October 29, 2022.

Ricky Mulvey: Asit, this sounds like a lovely community event, and it does not involve candy.

Asit Sharma: Let's switch from onion rings to one of the myriad flavors of milkshakes that are also very popular at Cook Out.

Ricky Mulvey: Also, not a candy.

Dan Boyd: Not a Halloween candy. If somebody gave my child, if they dumped a milkshake into his candy bag on Halloween, trick or treat, I think everybody involved might be a little bit upset about that. 

Chris Hill: Here on Motley Fool Money, we take our Halloween candy power rankings very seriously. I'm Chris Hill with just hours to go before Halloween, Ricky Mulvey and Asit Sharma are diving into the business of candy. They'll take a closer look at Hershey's market-beating strategy and why shrinkflation is hitting your trick or treat bag. 

Ricky Mulvey: What's back this year's shrinkflation, which is nothing new for candy. According to a Washington Post story, in the 1950s, candy companies told vending machine operators that they would have to raise prices going from five cents for a piece of candy to six cents. The vending machine folks balked and ask that the candy companies just make the products smaller. You're seeing this across the board with consumer goods in general, Asit, but I think you're seeing it extraordinarily prominently, or extraordinarily prominently is out a phrase. You're seeing it prominently in the candy space, at least from my consumer experience.

Asit Sharma: Yeah, as you point out, this has been going on for a while, Ricky, I think one of the things that makes candies such an easy target for shrinkflation is that we have innovation in packaging. There's not a lot of innovation in some of the small pieces of candy, small items you'll pop into your mouth. But we come up with ingenious ways to divide them up into smaller pieces to then individually shrink wrap those pieces within a larger package. The machines get more automated every year. I know I've been studying collaborative cobots, and their ability to now pick and pack stuff. When you can show a CFO that look, we can shrink this a little more this year because the packaging just got a little bit lighter and our profits are going to go up. They love that. This is going to go on until, I don't know, several generations from now. Ricky, your descendants will be using a microscope to find their candy when they open a package. But they'll still be paying the same price as your family was is 1950. Same package.

Ricky Mulvey: Financial engineering killed the candy bar, according to the Washington Post story, a bag of dark chocolate Hershey's Kisses is now a couple of ounces smaller than before. Two pack of Reese's Cups is a 1/10 of an ounce lighter and a Cadbury milk chocolate bars or 10 percent skimpier. Another example that I got was from @janneyswave25 on Twitter because I was complaining about the size of what Hershey is now calling a king-size bar. It is Quaker Oats Instant Grits. She used to get 12 in a pack, now she's getting 10, and now they're slightly less than one ounce. But I think you're seeing that most prominently in the chocolate space. I'm going to show you an example because for this show I did some consumer research, Asit. I went down to the 7-Eleven. See what Hershey was offering because we're going to talk about the company more.

Asit Sharma: You're so dedicated.

Ricky Mulvey: I'm a Peter Lynch investor, which means I see products in my everyday life and then I either buy the stock or not based on no more research. This is what Hershey's is calling a king-sized bar now. It is 2.6 ounces. So basically if you're imagining this at home, it's enough chocolate to cover about two s'mores. This is what is now being called a king-size bar. To your earlier point, where you're saying these candy companies are getting cute with the financial engineering and the different robots doing packing stuff, I would counter that, sir, and say that in many cases they're just simply lying about what constitutes a king-size amount of chocolate.

Asit Sharma: The question is, are we gullible or are we just addicted? Are we gullible enough to say, oh, that's a king-size, that's going to do me or maybe I need two king sizes or are we just addicted at the end of the day, we go through the aisle. We grab a couple of three king sizes because we don't care anymore what we pay. We need our chocolate fix.

Ricky Mulvey: Let's put the spotlight on some Halloween/Candy companies. The one I've been diving into a little bit is Hershey, founded in 1894, hey, it's been on the New York Stock Exchange since 1927. When you think of a market-beating company, you might not think of the Hershey chocolate company. However, it's a dividend knight. We did a show with Matt Argersinger and Anthony Schiavone awhile back, they found a list of companies that fit into these categories. It's paid a dividend for 10 or more consecutive years. It's grown that dividend by more than 10 percent annually over 10 years, and it's beaten the Standard and Poor's 500 over that 10-year period. Asit, are you surprised to learn that Hershey fit into that category because when I was in business school, Hershey was one of those stodgy or ballast like companies where you're not expecting a market-beating return, but you're also not expecting to lose your money by investing in the stock?

Asit Sharma: I'm surprised and not so surprised by that, Ricky. I've had a conversation with Matty recently about dividend stocks in which we were both pointing out that the expectation of providing a steady dividend or the expectation to increase that dividend makes you run a business in a responsible way. This solid cash-flow business, which has been around for so long, has a good chance of at least trying to keep up with the rate of inflation. That's what good consumer goods multinational companies tried to do. They tried to grow their revenue at or above inflation. A couple of percentage points above is a great target. Now, why it is a little surprising is because in this day and age, you have to make the right bets.

We've seen a lot of consumer goods companies that also play in the chocolate space by pet food companies to get that extra kick in revenues. If you think about Mars, which is privately held. If you look at General Mills, which has some candy exposure, these are companies that are buying into premium spaces and the CG world. It's fraught with risk because you can make the wrong bets. This tells me that Hershey is doing OK in its M&A strategy, which I know you wanted to talk about. But this is one of the hardest things to do in the CG world. When you've been to stodgy business, how do you grow? How do you buy the right companies to give you that extra bit of sauce where someone like Ricky Mulvey will come and say, yeah, this is a dividend knight, I like this. This is interesting.

Ricky Mulvey: I'm not saying you're dividend knight or not. That's based on the spreadsheet numbers. Hershey has been big on the M&A. CEO Michele Buck wrote in a Harvard Business Review piece, if you're curious about how Hershey has turned the business into a market beater, I highly recommend the article. She says that her goal was to turn it from an iconic confection company to a leading snacking powerhouse. It's made a couple of acquisitions including Amplify Snack Brands, which includes SkinnyPop and Paqui spicy tortilla chips, Pirate Brands, which includes the Pirate's Booty snacks that you've seen in a grocery store and also Dot's Pretzels. It's a part of that better for you strategy. They're not going to call it healthy. They'll call it better than a piece of chocolate. If you look at the growth categories for Hershey, Pirate Brands and Dot's Pretzels, or the sales growth after the acquisition has been growing by at least 30, 40 percent. I think to your earlier question, it's because Hershey's able to go in and say, we have a lot of capabilities that can help you grow your sales. We know how to sell food to people at a mass scale and that makes those mergers and acquisitions in easier solve for those companies.

Asit Sharma: This is a very interesting strategy. What you just named, that the brands that Hershey acquired, they're actually at the intersection of two or three categories. They are in that good for you circle, they're also in that occasion circles. I've got movie night and they're also in what's called the indulgent or semi-indulgent category. You want to treat yourself, you might pick up a bag of Pirate's Booty some people, because it's not quite as bad for you as another choice, so you're more likely to buy it. SkinnyPops, the Paqui's spicy tortilla chips are some people's substitute for Doritos. In that intersection of three circles, they made the right bets. This again is what I say is very difficult when you become a multi-billion-dollar CG conglomerate to pull off. I think this is where Michele Buck might've had an edge in the past few years. The other thing I'll notice, they didn't overpay for any of these franchises. None of these were deals that were so big that they had a risk of actually harming the bottom-line. I believe Amplify was actually a publicly traded company. If memory serves, maybe there was a little bit of stock as well involved in that deal. Now, write in and let us know if my memory is wrong. But these were smart acquisitions too.

Ricky Mulvey: Besides acquisitions, I think Michele Buck laid out the strategy in the Harvard Business Review article and said that the company had been leaning too heavily on product innovation to drive growth. To your point of family movie night, she started focusing on these more on packaging. When do people consume Hershey's products? We investigated consumer occasions on which our products could play a role, such as family movie night. We developed a more user-friendly way to buy our brands, for example, those are the resealable stand-up bags that can hold up in a pantry, in packs of single-serving treats. I think that makes a lot of sense for the company, which is, you've already figured out the product line, now it's just figuring out ways to make it more readily available for consumers.

Asit Sharma: Before we move on, Ricky, can we zero in on one word that you just mentioned, which is line. Typically when you're looking for innovation in this space, what you're really doing is asking the question, how can I just have SKU proliferation?  You think the answer is having different versions of the same products and lots of them. That's most of the time what we see in consumer goods. When CEOs and CFOs talk about product innovation, that's really what happens. Then you've got to figure out how do we get this through lines, and I'm talking about manufacturing lines. Often at times it doesn't help the business at all, but I think this is another level of thinking that Hershey put in. Again, it's a little more purposeful and a little more targeted at something that's going to drive an incremental return on investments. I love this thinking.

Ricky Mulvey: The expanding and contracting product offerings is nothing new. When Milton Hershey had started making candy, at one point he had more than 100 products. He had to focus on caramels and then chocolate. It's interesting to see the similar problem play out more than 100 years later. For the stockiest of stock investors in the back of the room, we got 4.7 price-to-sales, it's about 48 times price to free cash flow, we've got 23 percent return on invested capital, a 43 percent gross margin, and Buck has been responsible with the share count. Two hundred and five million shares outstanding now, 211 million shares outstanding in 2018. Even with the acquisitions, you're not seeing an exploding share count for the Hershey Company. Asit, you're the analyst. I just host podcasts around here. Any of those metrics stand out to you?

Asit Sharma: If I found these metrics out in the wilderness, I would say that 48 times free cash flow, that sounds high to me. But now you've presented this on a trailing basis. But you also present us, Ricky, with a 23 percent return on invested capital, which is pretty darn good for a manufacturer of this size. I do also like the reduction in share count. I'm not a huge fan of share buybacks if there are really persuasive uses for that capital, but in a mature business, sure. After a few decades, let me see some reduction in share count if you've got some excess cash that you're either generating or it's lying around on the balance sheet. Those all stand out to me as reasonable, somewhat attractive. Then you look at this 43 percent gross margin and think to yourself, that also sounds like a pretty mature business. Now, bear in mind, Hershey's has had decades and decades to try to push above, I don't know, a 50 percent, 60 percent gross margin. But as you told us at the beginning of this taping, Ricky, selling candy, selling consumables isn't the highest margin of businesses. On the surface of things, I would say Hershey is doing a pretty decent job with these fundamental metrics that you've laid out for us.

Ricky Mulvey: I'm looking into adding some ballast companies to my stocks. Here are my concerns with Hershey, one of which, this is my consumer experience. I went to 7-Eleven, I got the king size bar of Hershey, and when I looked at the price of just a regular old Hershey bar, I've realized that it's now more expensive to buy Hershey's chocolate than it is to buy a lot of what I would call more premium competitor. There's a company called Tony's Chocolonely, and they're selling these six ounce bars for I think it's about five dollars, and then the price per ounce for this premium chocolate bar is now less expensive than what Hershey is giving me through their cool shrinkflation tactics. That's number 1. Then second of all, I think there's still a lot of supply chain concerns that I have with Hershey.

They released very long ESG reports and while I think it's great that they're focusing on board diversity, when I go on my Hershey's chocolate bar and I scan the QR code to find out where the chocolate is coming from, it takes me to a broken web page. Which tells me that they're not going to tell me. I really don't like it because I think for something like chocolate where you have a very fraught supply chain, where you're getting the cocoa from a lot of these West African countries with small growers, where there are things that can go very wrong for the people working in that area, you have to be extraordinarily transparent about how that's going and where the chocolates coming from.

Asit Sharma: Yeah. Ricky, the first of those two points is a question of brand risk, and the second of those two points is a question of appetite. To the first, you're definitely onto something there. Every brand that is really, really established with every generation, they have to reestablish themselves. Nike goes through this problem. They're an example of a company that does brand extension really, really well. As one generation ages, the next generation wants a pair of Nike's. Why? Because Nike is very persuasive on TikTok. They're in the metaverse. They spend a lot of money on technical innovation, so their products are usually good. Hershey is up against some splitting in consumer preferences. You do have like a raft of almost, they look like bulk candies, as you've mentioned, some big chocolate bars right at the checkout in colorful packaging to attract maybe some younger consumers. Then this explosion of candy bars, you know the type I'm talking about where they show you the percentage of coco on the wrapper and they mix in some hazelnut or something. Will the younger generations still have the loyalty to Hershey's that older generations did? That's something we'll have to find out.

Ricky Mulvey: Any other Halloween candy companies you want to talk about? We can talk about Tootsie Roll, we can talk about PepsiCo, or do we want to move on to our power rankings?

Asit Sharma: You know we have to do power rankings.

Ricky Mulvey: We have to do power rankings.

Asit Sharma: Give the people what they want, Ricky.

Ricky Mulvey: I reached out to some Fools and I asked for the top Halloween candy power rankings, and you would be surprised at what we received because in some cases, it wasn't actually candy. Dan Boyd, the man behind the glass, you want to come in and help us out with some Halloween power rankings.

Dan Boyd: Absolutely.

Ricky Mulvey: Asit, I'm going to let you go first. What do you have for your top three Halloween candies?

Asit Sharma: Reese's. You got to have Reese's, and this is based on years and years of midnight snacking. Number 2 for me, those small Snicker bars that are just such a joy to unwrap. You want to just find another one after you've eaten the last one. You're riffing around in the dregs of the bowl to find one more Snickers package. Number 3, onion rings.

Ricky Mulvey: Not a candy.

Dan Boyd: Doesn't count.

Ricky Mulvey: It doesn't count.

Asit Sharma: This was supposed to be by locality. In my locality, I wanted to give a shoutout to the older generation, anyone who's above 13 or 14 maybe has a driver's license because where I live in North Carolina, it's becoming more and more of a tradition to go to a place called Cook Out, which is a shotgun type drive-through that has in nearly every city, in which they set up shop, a long line of cars at 2:00 and 3:00 AM. I should be honest here, not just on Halloween, but every weekend. 

Ricky Mulvey: Asit, this sounds like a lovely community event and it does not involve candy. Dan, you?

Asit Sharma: Let's switch from onion rings to one of the myriad flavors of milkshakes that are also very popular at Cook Out.

Ricky Mulvey: Also not a candy.

Dan Boyd: Not a Halloween candy. If if somebody gave my child, if they dumped a milkshake into his candy bag on a Halloween trick-or-treat, I think everybody involved might be a little bit upset about that.

Asit Sharma: Fair enough. I will then go with Watermelon Flavored Jolly Ranchers.

Ricky Mulvey: That's a candy. There you go. Ding, ding, ding, you got there. I'm much happier. Dan Boyd, do you have a list of beef jerky or potato chips you'd like to add for your top three Halloween candies?

Dan Boyd: I have had chocolate-covered potato chips before, which were pretty good, but I'm not going to count them as Halloween candy because I'm not a crazy person.

Ricky Mulvey: You respect the rules.

Dan Boyd: I will go with my number 1 is the min-sized Snickers. Now I looked up the Snickers size chart before the show here so I was accurate in this, this is, of course, the smallest sized Snickers you can buy. My thing with those is I can't really eat a full Snickers bar on its own. I think it's too rich. It's too much. But I'll eat about 100 of those mini-sized snickers in one sitting, if you'll let me. So those things are pretty great. Second is the KitKat. I like the crunch. That's really it. It's just a good crunch. Third, and this is a little bit of a dark horse and I think might anger some people out there, is the Heath bar.

Asit Sharma: The Heath bar?

Dan Boyd: I love the Heath bar, the crunchy toffee on the inside. You can't beat it, man.

Ricky Mulvey: I think with the mini Snickers bar, it's all about the ratio. Because with the regular Snickers bar, you're just getting too much filling and then you're not getting the chocolate on the ends. So it's not that perfect bite once you get into the middle of it.

Asit Sharma: We should specify, you're talking about the one that's not the size of like.

Dan Boyd: Not the fun size.

Asit Sharma: You're talking about the one that's like the size of a quarters one?

Dan Boyd: Yeah, the smallest one. Yeah, that's the best one. It's got the correct ratio of chocolate to filling, if we're going to be honest there.

Ricky Mulvey: Dan Boyd celebrating shrinkflation. I've got three. Surprised I haven't heard it yet. I've got Sour Patch Kids, number 1. That to me is obvious. It is. First it's sour, then it's sweet. It's two candies in one. Don't shake your head. Respect the Sour Patch Kids. Number 2, it's the mini Reese's dark chocolate. It's very specific, but I think the peanut butter mixed with the darker chocolate is a significantly better combination than the milk chocolate.

Dan Boyd: Wow, OK.

Ricky Mulvey: Number 3, the KitKat, that's an easy one. Also the mini-sized. Simple, crunch. That's all you need. Then I'm going to give two honorable mentions because these are candies that aren't necessarily Halloween candies, but they are candies unlike Asit's list of potato chips and beef jerky.

Dan Boyd: Milkshakes.

Ricky Mulvey: Milkshakes. Excuse me.

Asit Sharma: I tried.

Ricky Mulvey: We've got, I think it's more popular internationally, but it's these Kopiko coffee hard candies that are like these sweet coffee candies that are actually pretty good. Then out of Cincinnati, Ohio, the French Chew Mini. It's these like Tootsie Roll size, little salt water taffy, things that are absolutely delicious. You can get them in vanilla, strawberry, banana, and it's just a delightful, little treat that takes me back to the boardwalks of Cincinnati, Ohio.

Dan Boyd: Ricky Mulvey getting both hyper-regional and international at the same time. You love to see it.

Asit Sharma: I should say, low culture and high culture as well. That dark chocolate description made me realize what a connoisseur Ricky is.

Ricky Mulvey: Thank you. Then two more as we wrap up because I reached out to other Fools. Anand Chokkavelu, he gave us three: Snickers, Reese's Cups, peanut M&Ms, and the non-chocolate runaway winner of Sour Patch Kids. I think that was just to hide his chocolate and peanut bias.

Dan Boyd: I mean, he's right, though. Chocolate candies are always better than non-chocolate candies.

Ricky Mulvey: On Halloween, for sure. Dylan Lewis, KitKat, Snickers, Reese's, and then an honorable mention to Almond Joy and Gushers. Dylan Lewis, I wish you were here because Gushers is not a Halloween candy. That is something you put in a lunch.

Dan Boyd: That's a fruit snack. Yeah. Did you say sneakers there?

Asit Sharma: I thought he did.

Dan Boyd: Because I mean, listen, I like wearing shoes as much as the next guy, but I ain't about to eat my Vans.

Asit Sharma: I'll eat them, but I need some chocolate on them.

Dan Boyd: There you go.

Ricky Mulvey: That's as good a place of as to end the Candy Industry Focus. Asit Sharma, always good to see you. Dan Boyd, thanks for chatting candy with us.

Dan Boyd: You're welcome, Ricky.

Asit Sharma: So much fun, gents.

Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.