EUR 850.00 For Business Accounts Only

Morningstar | Wide-Moat Hershey's 1Q Whopper Profits Evidence Merits of Its Strategic Course; Shares Fairly Valued

By all accounts, Hershey started 2019 on a sweet note, chalking up 1.9% organic sales growth (a 1.7% benefit from higher volumes and 20 basis points from increased prices, on top of a 1% uptick in the year-ago period), 80 basis points of adjusted gross margin improvement to 45.7%, and 160 basis points of expansion at the adjusted operating margin line to 23.3%. While we anticipate that its underlying sales trajectory will remain a focal point over the next several quarters (given the languishing metrics that have been posted by firms throughout the consumer product landscape of late and as a number of industry participants are opting to raise prices to offset pronounced inflation that has weighed on profits), we posit that Hershey’s leading brand mix, entrenched relationships with retailers, and vast array of resources to invest in new products and marketing support (which in combination underpin the intangible asset source of its wide moat) should ensure it withstands these headwinds.

Management held the line on its fiscal 2019 sales growth (1%-3%) and earnings per share ($5.50-$5.66) outlook, which squares with our pre-announcement forecast (1.5% and $5.50, respectively). Despite the mid-single-digit bounce in shares following results, we don’t anticipate altering our $123 fair value estimate (outside of a $1-$2 bump to account for additional cash generated since our last update). Further, we don’t foresee any changes to our longer-term forecast, which continues to call for 3%-4% average annual sales growth and operating margins improving to more than 23% over the next decade (around a 270-basis-point increase relative to the average over the past five years). But with shares trading in line with our valuation, we’d suggest investors await a more attractive margin of safety before building a position.

Overall, we believe management is taking proactive steps to solidify its edge, even in the face of intense competitive and macro challenges. For one, we’re encouraged that Hershey remains committed to intentionally rationalizing its portfolio mix as a means to ensure it is allocating shelf space and investment dollars to the highest-return opportunities (despite the inherent hit to sales, which management has refrained from quantifying). In addition, we surmise its pursuit of extracting costs and complexity from its operations (aiming to remove $150 million-$175 million in costs, a low- to mid-single-digit percentage of cost of goods sold and operating expenses) should afford it added funds to support its leading brand mix; our forecast calls for Hershey to direct around 8% of sales (more than $700 million on average annually) to research, development, and marketing over the course of our 10-year explicit forecast. But rather than just broadly dividing these resources across its fare, we view Hershey’s efforts to reduce spend on its smaller brands (where marketing has failed to elevate sales performance), while also leveraging its analytical insights as a means to reduce non-consumer facing spend, as prudent means to ensure that these investments prove value-enhancing.