Hershey: Q4 And Full-Year Results Highlight Solid Growth (NYSE:HSY)

Investment Thesis

Hershey (NYSE:HSY) had what can only be considered to be a solid 2023 with great topline and bottom-line growth, illustrating the pricing power generated by the firm’s iconic selection of branded products.

The coming fiscal year presents the firm with some real challenges compared to 2023, with higher cocoa prices, potential for an economic slowdown and increasingly stressed consumer pocketbooks, creating a difficult environment for Hershey to manage in 2024.

Current valuations appear to have mostly priced-in expected growth for 2024 with any short-fall in growth potentially creating downside risk relative to current share prices.

Nevertheless, I still believe the firm’s wide economic moat should allow the firm to outperform in the long-run and continue to rate the firm a Buy at present time.

Company Background

The Hershey company is the largest confectionary manufacturer in the U.S. with over 19,000 employees and 100 brands under their belt. The firm specializes in the development, production, marketing and sale of sweet and salty snacks and treats.

An iconic portfolio of products including Milk Duds, Dot’s Pretzels, Twizzlers, Kisses, Hershey confectionary and Reese’s treats generates massive pricing power and moatiness for the firm’s operations.

Hershey is also rapidly expanding their product offerings into new international markets, with a focus on the European continent, potentially creating a new growth avenue for the confectionary giant.

Earnings Analysis – Q4 FY23 & Full-Year Update

I conducted a full in-depth analysis of Hershey’s economic moat, profit drivers and fiscal profile in an earlier article written just a few months ago.

I recommend reading that piece titled: “The Hershey Company: Deep-Dive Analysis Reveals A Tasty Opportunity“, to gain a better understanding of The Hershey Company’s business.

In this update article, I would like to discuss their Q4 and full-year 2023 results in detail and discuss how cocoa prices may impact the confectionary manufacturer in 2024.

The final quarter of the year saw Hershey’s net sales flatline YoY at $2.7M along with a reported net income of just $349M, down 11.5% YoY.

These slightly uninspiring results were due to planned inventory declines within the North America Salty Snacks segment, which resulted in a massive 24.6% YoY drop in revenues from the segment.

Hershey’s North America Confectionary and international business segments actually grew 2.1% and 12.7% YoY respectively, which illustrates to me that their products still resonate and attract consumers even despite the inflationary macroeconomic environment.

Great progress in the firm’s strategy to increase supply chain efficiency and net price realization helped minimize operating costs for the final quarter, resulting in a tremendous 50bp expansion in adjusted gross margin to 44.2%.

I see Hershey’s supply chain leaning as a very positive development, with the firm being flexible enough to adapt to a new business environment characterized by higher price levels and significantly inflated sugar and cocoa costs.

Full-year 2023 results saw The Hershey Company grow their revenues by 7.2% YoY to $11.2B, with organic constant currency net sales increasing 7% YoY.

Adjusted net income for 2023 was $1.9B, which was a 13.8% increase YoY. The firm’s operating margin expanded around 2pp to 23.45% while their net margin saw a similar 2pp increase to 17.11%.

These solid results came on the back of Hershey facing significantly higher costs for the sugar and cocoa used in their products, along with a widely reported pullback in consumer spending on grocery items due to the inflationary macro environment.

Nevertheless, Hershey’s great confectionary and salty snack products have proved attractive to consumers, while their expansion into international markets has been received well according to the quantitative sales figures.

International sales increased 11.2% YoY for the firm, while North America Confectionary and Salty Snack sales also grew by 6.9% and 6.1% respectively in the period.

An improved product pricing and sales mix helped boost sales across Hershey’s business segments.

I view this situation as a supporting element of the hypothesis that the firm’s brands such as Pirate’s Booty, Hershey and Reese’s continue to resonate with consumers and differentiate from the competition on retail shelves.

The very same cost controls and supply chain efficiency improvements accomplished in Q4 helped to contract the firm’s COGS for 2023 from 56% (as a percentage of total revenues) to 55%.

While this improvement in efficiency may appear minimal, it is, in my opinion, truly remarkable for a few reasons. Firstly, let us not forget that Hershey managed to decrease their overall COGS even as revenues grew by 7.2% in 2023.

Secondly, Hershey has been faced with rapidly rising cocoa costs and sugar prices which have impacted the firm tangibly in 2023 according to management.

Considering these factors, I believe it became clear how remarkable such cost controls are in today’s macroeconomic environment.

However, it must be noted that in my view, Hershey has not yet had to face the total impact of rising cocoa prices as a result of the nature of cocoa supply contracts.

Many such supply deals are inked for multiple years, with only occasional price changes being allowed. Therefore, I believe the rising cocoa costs may impact The Hershey Company much more harshly in 2024 as compared to 2023.

This appears to be reflected in management’s less than stellar 2024 outlook, with 2-3% annual net sales being estimated for the coming year.

On the Q4 earnings call, management also highlighted that pricing power alone may be insufficient to cover rising raw material costs, resulting in a slight decline in operating profits.

The Hershey Company also raised their quarterly dividend by 15% to $0.178 per common stock share. This brings the current yield to 2.87% and continues their excellent 14-year dividend growth streak.

Management also announced a share buyback scheme, which should see the outstanding number of common shares reduce by around 1% in 2024.

A combined dividend increase and share buyback initiative acts as a superb vote of confidence from management in the long-term profitability, health and success of Hershey, illustrating that the team is thinking much further ahead than just the coming year.

Overall, I still really like Hershey’s profitability, efficiency and ability to continue growing sales even amidst a difficult macroeconomic environment. The power of their brands helps Hershey to attract customers to their products and away from cheaper alternatives.

If cocoa prices remain elevated for a long time period, I believe the firm’s overall COGS may increase tangibly, resulting in a declining operating and net margin. Still, the firm’s overall brand portfolio appears to be in great shape and sets the scene for great long-term performance.

Valuation

Seeking Alpha’s Quant now assigns The Hershey Company with a “D+” Valuation grade. I still find this rating to be an excessively pessimistic assessment of the overall value present within the firm’s shares.

The stock currently trades at a P/E GAAP TTM ratio of 21.10x. I find this to be a pretty decent ratio for Hershey’s stock given the firm’s long-term growth prospects and the current 20% decrease compared to a running 5Y average.

Hershey’s P/CF FWD of just 14.23x is also still reasonable, while their Price/Sales FWD of 3.39x is also quite understandable. While both of these metrics are well above a traditional ‘value’ definition, I believe the current markets are pricing-in the 8% annual revenue growth expected for the firm in the long term.

Considering a 5Y chart, Hershey shares are trading at a real discount compared to the highs of around $274 seen in April 2023. The current stock price of $194 represents a massive 26% selloff compared to the all-time highs.

Nevertheless, I find it important to recall that even with this significant price correction, The Hershey Company’s stock has matched the S&P 500 tracking ETF, “SPY” (SPY) over the same 5Y period.

The last three months have seen the stock languish compared to the general markets as an uninspiring outlook for both the macroeconomic backdrop and cocoa prices have decreased investor optimism in Hershey’s stock.

Next, let’s use The Value Corner’s Intrinsic Valuation Calculation so that we may better understand what value exists in the company from an objective perspective.

Using the firm’s current share price of $194, an estimated 2024 EPS of $9.66, a realistic “r” value of 0.08 (8%) and the current Moody’s Seasoned AAA Corporate Bond Yield ratio of 4.87x, I derive a base-case IV of $213.80. This represents just a 9% undervaluation in the firm.

When using a lower CAGR value for r of 0.05 (5%) to reflect a scenario where higher cocoa prices cause Hershey’s overall profitability to fall, shares are only valued at around $161.50 representing a 20% overvaluation in shares.

This worst-case scenario serves to illustrate how much growth is being baked-in to The Hershey Company’s current valuations. Any shortfall from the 8% revenue growth estimates would almost certainly result in shareholder value destruction.

Considering these factors, I believe that The Hershey Company is trading at what may be considered a fair valuation given their growth prospects.

In the short term (3-12 months), I find it difficult to make any concrete predictions. Given the consumer discretionary nature of the products sold by Hershey, I see much of their future growth dependent on the overall health of the U.S. consumer and economy.

Any short-term macroeconomic issues could tangibly impact the average consumer and result in falling sales and profitability at the confectionary company.

Sustained high cocoa prices could also result in a real increase in the firm COGS, which could degrade their operating margin and net income substantially.

In the long-term (2-10 years), I still see The Hershey Company continuing to utilize their wide economic moat to capture sales, grow their market position and generate great returns for shareholders.

The Hershey Company’s Risk Profile

Little tangible change has occurred to Hershey’s risk profile since my last article, with the firm still facing real threats from a cyclical market environment, degrading brand power and the higher cocoa prices resulting from poor farming yields.

What I would like to highlight is how the cocoa price threat is changing for the firm. As discussed earlier, most cocoa supply contracts are set for significant periods of time and thus relatively immune from commodity price fluctuations.

Therefore, the real risk from the current cocoa prices could impact Hershey significantly should the firm be required to negotiate new supply deals while prices remain high.

I would also like to discuss the increasing data available regarding the effect weight-loss drugs are having on consumer spending habits. Recent analytics has found that diet drugs such as Ozempic reduce overall grocery store spending by around 9% per trip.

This decrease occurs mainly from a reduction in spending on sugary treats and confectionary.

Unsurprisingly, this places the majority of Hershey’s current product portfolio in the firing line, with consumers potentially spending less on these products as weight-loss drug popularity increases.

While these drugs are currently quite expensive and not expected to be adopted on a mass-scale anytime soon, Hershey must continue to develop their portfolio in a direction that considers consumer health and the changing tastes and preferences among their clientele.

I still rate Hershey as having an overall well-managed risk profile and still believe the firm makes for a credible ESG conscious pick.

These matters are of course subjective, and I strongly suggest you conduct your own research into the risks and ESG concerns facing the firm.

Summary

I still like The Hershey Company both as a business and as an investment opportunity.

I think the firm’s 8% annual revenue growth target and current potential for a 9% undervaluation place Hershey’s stock soundly in GARP territory, with a credible pathway to achieving this growth being present in my opinion.

Nevertheless, the firm does still face some real risks, particularly from elevated cocoa prices and a cyclical business environment with significant growth already being baked-in to the current stock price.

Considering these factors and the 2024 outlook, I rate The Hershey Company a Buy at present time and continue to believe the firm makes for an attractive long-term buy and hold pick.