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Hershey's Sweet Problem

By Daniel Jones - Mar 1, 2014 at 8:00AM

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Could Hershey's cash position prove problematic for the confectionery company?

Source: Wikimedia Commons.

Cash can be a tricky thing. If you don't have enough, similar to the situation that J.C. Penney faced late last year, it could signal trouble for your business. However, if you have too much, that could also be problematic. Probably the best example lately has involved Apple and Carl Icahn's push to force the company to repurchase $50 billion worth of shares over the next year.

While both of these companies are high-profile cases, there might be another cash-troubled business that could become the target of scrutiny in the future: Hershey ( HSY 0.67% ).

Hershey has a big cash issue
At the end of its 2013 fiscal year, Hershey reported that it held cash and cash equivalents of approximately $1.1 billion. Although this is just a fraction of the $40.7 billion in cash held by Apple during its most recent fiscal quarter, it represents a significant jump compared to the $253.6 million the company had on its balance sheet in 2009.

Source: MSN Money.

Based on the table above, we can see that Hershey's cash has risen every year since 2009, with the exception of the drop it experienced between 2010 and 2011. The jump in cash should be encouraging for shareholders because of the opportunities that it can afford them. However, having too much cash on hand can be a hindrance, as it can leave management wasting opportunity by keeping it in the bank or can prompt the company to make poor investment decisions solely for the purpose of using its cash.

But the big question here is not how much cash the company has on hand. Rather, it's whether or not the business has too much. As businesses grow, it's reasonable to expect them to hold more cash so that they can service their operations, so a nominal perspective won't grant the Foolish investor much insight. Instead, we should be looking at cash in relation to total assets, as demonstrated in the table below:

Source: MSN Money.

Using cash as a percentage of assets, we see that Hershey currently holds a larger share of its assets in cash than it has at any point over the past five years. While the high point of 20.9% isn't very far from the 15.9% the company has averaged over time, it's higher than the 19.6% held by Apple around the time Carl Icahn began pressuring management to find ways to distribute it to shareholders.

To some degree, management seems to realize that it must find ways to invest its cash. On top of adding new products like Lancaster Soft Cremes caramels, the business has been using some cash to repurchase shares and keeps them on the balance sheet as treasury shares. Between 2009 and the third quarter of 2013, the business increased its treasury shares by 18.6%, from $3.98 billion to $4.7 billion. What this means is that instead of retiring the shares it buys back, the company is keeping them on reserve so that they can be sold (or distributed for bonuses) at a moment's notice.

But alas! There's a catch!
Right now, Hershey's situation screams activist-investor target. However, this company more than any is protected against interlopers because of one party: Hershey Trust. In 1905, Milton Hershey, the founder of the chocolate giant, created Hershey Trust and in 1909 built the Milton Hershey School and School Trust.

With the aim of providing educational and care services for disadvantaged children, Hershey granted his trust an extraordinary level of control over his company. Today, that control continues to exist and makes Hershey an unassailable target for activists because of the 80% voting power the Trust has over both classes of the company's common stock.

Foolish takeaway
As we can see, Hershey appears to have something of a cash dilemma. With the business continuing to grow, the company is generating cash quicker than it can spend or invest it. In the short run this is fine, but eventually management would be wise to find some use for it. Aside from buying back additional shares, the company could raise its regular dividend, pay a special dividend, or engage in merger and acquisition activities.

Another potential solution would be to ramp up organic growth internationally. Over the past few fiscal years, the company's international sales growth has roughly doubled domestic sales growth. This could be a particularly attractive approach because of the fact that only about 16% of the company's sales come from non-domestic sources, which suggests great potential upside if management doesn't make too many mistakes.

No matter how the company handles it excess cash, it looks likely that shareholders could be in store for some sort of payoff, whether it be through a distribution or investment in the company's future. The only threat that shareholders should keep in mind is the possibility that the company may use its cash in a suboptimal way, because only then would they lose out.

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.

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The Hershey Company
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