The Hershey Company (NYSE:HSY) will benefit from higher spending on ads, product innovation, and price increases for its products in upcoming quarters. The company plans to increase its spending on ads as competitive activities in the industry, especially those of its competitor Nestle (NASDAQOTH:NSRGY), remain intense. Product innovation remains critical for consumer food companies, including Hershey and Kraft Foods (UNKNOWN:KRFT.DL), which will drive future sales growth. Also, Hershey expects to increase prices across its product portfolio, which augurs well for its margins and earnings growth.
A focus on improving sales
Hershey's sales increased by 2.4% year-over-year in the first quarter of 2014, below its long-term sales growth target of 5%-7%. Also, the company spent 3% less on ads in the first quarter and this affected sales. Hershey's performance in the quarter was also adversely affected by increased competitive pressure from Nestle, which increased its ad spending surrounding the Superbowl and supported the launch of its Butterfinger Cups. Along with increased ad spending, Nestle also ramped up its promotional activities. In the first quarter of 2014, Nestle's buy one, get one free trade promotion on Butterfinger Cups also heated up competition in the industry.
Hershey expects its ad spending to increase in the mid-single digits year-over-year in 2014. While Hershey spent 3% less on ads in the first quarter of 2014, it expects a high-single digit increase in the ongoing second quarter and the following two quarters to meet its 2014 guidance. An increase in ad spending will help the company address the intense competition in the industry and augurs well for its sales in upcoming quarters.
Aside from increased ad spending, product innovation also bodes well for the company's sales in upcoming quarters. The company has a solid new product pipeline for strengthening its product portfolio and keeping up with changing consumer demand. The company expects to launch several new products that include Hershey's Spread instant consumable items, York Minis, Ice Breakers Cool, and Brookside Clusters in the ongoing second quarter and the third quarter of 2014. The new product introduction, coupled with higher ad spending, will result in market share gains and sales growth and will help Hershey address the new product competition it faces from Nestle.
Product innovation has been very important for consumer food companies to increase sales and market share. Like Hershey, Kraft Foods is also targeting product innovation to support sales growth and maintain a solid product portfolio. Kraft has been consistently working to reformulate its existing products and introduce new products to maintain its market dominance. Kraft has high household penetration and holds dominant market positions in a majority of its product categories.
To facilitate on-the-go drink and food demand, Kraft plans to come up with customized sizes and packaging for its products. Also, Kraft has been working on lowering calorie counts, increasing freshness, and including simple ingredients in its products to keep up with the increasing health consciousness of consumers. Product innovation has been a vital and important sales growth driver for Kraft in recent years, which is evident from the fact that product innovation contributed 10.4%, 13.4%, and 14% toward its total revenue in 2011, 2012, and 2013, respectively.
Passing the buck
As commodity input costs are on the rise, Hershey expects to increase product prices across its portfolio. Since the beginning of 2014, cocoa prices have increased by 16% and milk prices have surged by 20%. As Hershey sells products with less price elasticity that consumers view as affordable luxuries, price increases will not only help the company pass on inflation to consumers, they could also help expand its margins and earnings growth.
Also, the company can increase prices by more than the rise in commodity costs, which augurs well for its earnings. In 2012, Hershey increased prices of its products by 6% on average, which resulted in a 2% increase in sales volume, a 140 basis point increase in gross margin, and a 14% year-over-year increase in EPS. Investors could see potential price increases as an opportunity for Hershey to expand margins and a positive catalyst for the stock.
Hershey has a solid product portfolio and its product innovation efforts remain aggressive as it bids to keep its portfolio solid and address the competition. Also, ad spending for the company should increase in the near term, which will not only address intense competitive activities in the industry, it will also support new product introductions. In addition, the potential for price increases in response to commodity-cost inflation augurs well for the company's future performance.