EUR 850.00 For Business Accounts Only

Morningstar | Hershey's Thirst Has Yet to Be Quenched Following Pirate Brands Tie-Up; Shares a Touch Undervalued

Building off of the deal that brought Amplify to its fold late last year, Hershey has announced its intentions to scoop up Pirate Brands (including the Pirate’s Booty, Smart Puffs, and Original Tings brands) from B&G Foods. The deal, valued at $420 million, is slated to close in the fourth quarter of calendar 2018. We estimate the acquired mix will contribute just a low-single-digit percentage to sales, and as such, it doesn’t stand to alter our $116 fair value estimate (based on 3%-4% annual sales growth and a more than 300-basis-point increase in operating margins to nearly 24% by fiscal 2027). However, shares trade at less than a 10% discount to our valuation, and we’d suggest long-term investors await a slightly more attractive entry point before building a position. For investors looking to snack on confectionery fare, we’d recommend wide-moat Mondelez as a more attractive option.

CEO Michele Buck has expressed an interest in pursuing further tie-ups (particularly those that expand the firm’s reach within the health and wellness realm on its home turf, with an ideal target slated in the $300 million-$400 million range), and this deal aligns with that sentiment. Firms throughout the consumer product industry have succumbed to lackluster sales and volume, and we believe this deal affords Hershey another avenue by which to elevate its sales trajectory. For one, we surmise Hershey will likely look to broaden the distribution of Pirate Brands’ product mix into the convenience, drug, and mass markets, where Hershey has a strong foothold. We aren’t blind to the competitive and inflationary headwinds plaguing firms across the landscape, though we posit that Hershey will weather these challenges with its leading brand mix, entrenched retail relationships, and vast global scale (which underlie our wide moat rating).

Hershey has historically operated with capital-allocation prudence--reflecting the sizable ownership stake of the Milton Hershey School Trust (which maintains more than 80% voting power, despite its mere 30% ownership share), an operation that depends on the stable cash flows the business generates--and we don't think it will veer from this prudence. As such, we don't intend to alter our Standard stewardship rating. But despite its bent to pursue inorganic growth opportunities, we don’t portend the firm will hold on to laggards under the guise of driving growth, following the announcements earlier this summer that it is parting ways with two loss-making businesses in Tyrrells (the international piece acquired with the deal for Amplify late last year) and Shanghai Golden Monkey (the Chinese confectionery business Hershey scooped up in 2013, which has been fraught with challenges, as Hershey has incurred impairment charges amounting to nearly half of the enterprise value at purchase), which we view as prudent.