Hershey (NYSE:HSY) reported quarterly earnings Thursday, and while the numbers were higher than expected, this Fool is left rather underwhelmed. Over the past few years, the company has cut costs to the bone in an effort to offset higher commodity prices and boost profits. This is also a fairly leveraged candy company, dependent on continued cost control and new products to continue to boost net income and boost key shareholder metrics such as return on equity. If any of those levers starts to fail, Hershey could become a gooey mess.
Keep in mind that sales were about $4.1 billion in 2001, and most analysts have that number pegged at $5 billion for 2006. Stretching across the same timeframe, however, profits have more than doubled from $199 million to my estimate of about $550 million this year. A quick peek at the income statement shows sales, general, and administrative costs (SG&A) increasing by only about $50 million over the same time span.
With all of that mind, let's try to figure out what this quarter's numbers tell us. Sales were up 6% to $1.05 billion, and net income rose about 5% to $98 million, including a $2.6 million dollar charge for "business realignment initiatives." SG&A costs for the quarter continued to decline by about 2%, helping net margins remain steady at 9.4% as rising interest expenses drained away some profit.
Being notably leveraged is not an unusual strategy for a consumer-goods company -- Anheuser-Busch (NYSE:BUD) has employed a similar strategy with great success for years. But the maker of Budweiser chose to grow sales a little faster than costs, which is a more sustainable strategy.
On the other side of the ledger, Hershey's new product pipeline for the first time in a while is not that exciting. In terms of new products, the Kissables line is quite successful, but the company exited the Swoops and SmartZones products last quarter. New products in the works are sandwich cookies based on existing products, which sound pretty mundane to me.
I'll grant you that the candy business can be tough, with Cadbury (NYSE:CSG), Kraft (NYSE:KFT), and even Sara Lee (NYSE:SLE) to some extent all competing for space on the same grocery aisles. But with the stock priced at a rich P/E of 27 -- higher than all-star Pepsi (NYSE:PEP) -- and expected long-term annual growth of 10% at most, I don't see any upside to these shares.
At some point, Hershey has to start growing the core business instead of hacking away at the costs. That growth has to come from some innovative products, not just another brand extension. For this chocoholic, the current approach just won't fly.
More sugary goodness:
- Folly Volley: Rocky Mountain Chocolate Factory
- Rocky Mountain's Bittersweet Quarter
- Land of the Free, Home of the Fat
Sara Lee and Kraft are recommendations in the Motley Fool Income Investor newsletter service, and Anheuser-Busch is a Motley Fool Inside Value pick. Try out these or any of our other Foolish newsletters for yourself, free for 30 days.
Fool contributor Stephen Ellis does not own shares in any companies named above. You can see his holdings for yourself. The Motley Fool has a yummy, gooey disclosure policy.
