The Hershey Company

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

The Hershey Company is a global confectionery giant, primarily known for chocolate and non-chocolate confections, with a strong presence in the North American market.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Hershey’s moat stems from its iconic brand portfolio, particularly within the chocolate confectionary space, which commands strong consumer loyalty and offers a degree of pricing power. This creates a barrier to entry for potential new entrants.

However, this moat is not impregnable, as the company faces competition from other established brands and a changing consumer landscape. There’s a growing trend towards healthier snacking options and away from sugary treats, which could threaten future value creation and market share. Also, as the recent earnings reports have proven, the high cost of sugar has an impact on the gross profit margin and the consumers might choose cheaper alternatives.

Business Overview:

Revenue Distribution:

  • North America Confectionery: This segment is the primary driver, accounting for around 85% of the revenue and focuses on chocolate and sweets products including iconic brands.
  • North America Salty Snacks: This segment focuses on salty snacks with several brands in this segment and constitutes less than 10% of the revenue, and a lower margin profile.
  • International: The international segment accounts for the remaining revenue, focusing on growth opportunities in a variety of emerging markets, with a higher exposure to currency risk.

Trends in the Industry:

  • Health and Wellness: Consumers are increasingly seeking healthier snacking options, including low-sugar, organic, and natural choices. This trend presents a challenge to Hershey’s traditional product portfolio which is dominated by sugary sweets.
  • E-commerce Growth: Online sales are a growing part of the consumer retail landscape, where more and more consumers expect convenience of buying snacks and other goods online.
  • Intense Competition: The confectionery market is highly competitive, with constant pressure from new entrants, established brands, and private labels.
  • Ingredient Volatility: The prices of major ingredients (especially sugar) have been volatile which affects production costs.
  • Inflation: A high inflationary environment increases input costs and poses challenge to margins.

Margins

  • Gross Profit Margin: In 2022, Hershey’s gross profit margin stood at approximately 44%. The pressure from increased input costs, mainly sugar, and the need for more promotion and advertising, has been the cause for slightly declining margins for the year 2023
  • Operating Profit Margin: HSY operating margins also took a slight hit in 2023 due to the same factors mentioned above.
  • Net Profit Margin: The company maintains a net profit margin averaging around 15%.

Competitive Landscape:

  • Intense Rivalry: Hershey’s operates in a competitive landscape with formidable players like Nestle, Mars, Mondelez, and other chocolate and snacking companies. Each of these players have their own strategies to maintain or increase their market share.
  • Threat of Substitutes: The increasing popularity of healthy snacks poses a threat to Hershey, whose products are considered to be full of sugar and high in calories.
  • Private-label competition: Lower-priced private labels can take share away from brands, though they are less powerful in confections than other sectors.
  • Power of Suppliers: The company is dependent on its raw materials and hence is exposed to fluctuations in commodity prices, primarily sugar, which is an important cost input.

What Makes Hershey Different:

  • Iconic Brands: Hershey has a wide portfolio of iconic chocolate brands that have been around for generations. These brands come with strong consumer loyalty, and allow the company to have some price flexibility.

  • Distribution: Hershey has a strong distribution network that gets its products to a wide variety of customers and retail stores globally.
  • Innovation: The company also keeps innovating to keep up with consumer preferences and stay relevant. They are expanding their offerings of chocolate products and salty snacks.

Financials:

  • Revenue Growth: Hershey has shown steady revenue growth over the last few years, with net sales of $11.2 billion in 2023 (excluding currency effects) which is an increase of 12% compared to 2022.
  • Profitability: The company has maintained strong profitability, but there has been a compression in gross margins due to the higher input costs and increased investment in the business. However, these higher investments have led to higher revenues.
  • Return on Invested Capital (ROIC): The company’s return on invested capital is still high, around 20% and has stayed steady for the past few years.
  • Cash flow: The company has generated steady cash flows from operations as well. However, this cash flow is used to improve the business and also to pay debts and repurchase stocks.
  • Debt Structure: The company has a moderate long-term debt, and its cash balance is about $400 million. With its great cash flow, the company can pay its debts easily.

Understandability: 2 / 5

The company, at its core, manufactures and sells chocolate and confectionary products. However, the number of brands, various geographic segment operations, and the complex process of valuation make it difficult to fully understand the company’s financials easily.

  • Business Model: The basic model of the company is straightforward. However, it is a mix of fast-moving consumer goods that have specific distribution and supply chains, and requires certain manufacturing capabilities.
  • Geographic Complexity: The revenue is divided among three segments which makes the operations complicated. It has domestic and international sales with a different customer base for each region.
  • Intricacies of valuation: To correctly evaluate the company, and factor in for fluctuations in currency and commodity, is a long process which might not be very simple for everyone to understand.

Balance Sheet Health: 4 / 5

  • Debt Load: The company’s debt is a manageable amount and easily serviceable due to its strong cash flows.
  • Cash Balance: Hershey has a substantial amount of cash reserves, which can be used to fund expansions and improve their business further.
  • Liquidity and Solvency: The company has healthy current ratio and adequate solvency ratios.
  • Intangibles: The company has goodwill that comprises more than 20% of the total asset which may be concerning, given that it is a non-performing asset.

Risks that Could Harm the Moat and Business Resilience

  • Health Trends: An increasing awareness of health and wellness has led to a decline in the demand for sugary confections, especially amongst the youth, which Hershey’s sells majorly. This might harm its revenue and overall profitability.
  • Commodity price fluctuations: Input costs, especially sugar, cacao, and labor, are critical to the company’s profitability. Increased prices will directly hurt the gross profit margin.
  • Competitive pressure: Intense competition from established brands and new entrants can squeeze profit margins and make it difficult to maintain customer loyalty.
  • Macroeconomic issues In recent times, higher inflation, supply chain issues and geopolitical conflicts are hurting the company’s performance.
  • Distribution issues : Since Hershey distributes through multiple channels, it faces complexity in distribution, and any misstep can affect their overall profitability.

Recent Concerns/Problems and Management’s Response:

  • Input costs: In recent earnings calls, management has admitted that high input costs (especially sugar) is negatively affecting their margins. Although, the management is trying to increase the prices to the customer, that may come with a loss in market share. In its recent earnings call, the company stated that they anticipate this problem will persist for the rest of the year.

  • Decline in volume: While the company has reported a significant rise in revenue, a significant portion was due to increases in price. The volume of units sold declined in recent quarters and will negatively affect future performance.
  • Supply Chain Issues: Due to various international factors, the company is facing some issues in logistics and availability of goods. Although they have tried to mitigate it by setting up a reliable supply chain, it is difficult to solve it in the long term.

Despite these issues, the company is confident in its long-term value-creation strategy. The management has emphasized that they are focusing on their core markets and expanding into new categories, that are healthier alternatives. They are also investing in supply chain transformation and have implemented a long term plan to manage the effects of price volatility and inflation.

Overall, Hershey has a solid business that has some key advantages in its brand and distribution. However, like all businesses, there are always challenges, and the company must try to adapt to the changing needs to increase long-term value for shareholders.