Hershey Foods (HSY)

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Hershey Foods (NYSE HSY) is North America's largest chocolate producer with 42.5% of the US chocolate market.^[1] Hershey sells products in 50 countries under 60 brand names including, Hershey's, Reese's, and Kisses.^[2] In 2010, the company's net revenues were $5.67 billion with net income of $510 million.^[3] Additionally, Hershey maintains the right to manufacture and sell competitors' products, such as Kit-Kat bars, through licensing agreements with foreign Nestle (NSRGY) and the former Cadbury Schweppes (now part of Kraft Foods (KFT)).^[4] Although Hershey must pay for these rights, the company insulates itself from foreign competition through the agreements. With over 90% of its revenues coming from the United States, Hershey is one of the most geographically concentrated major food and beverage companies.^[2] However, the company has taken steps to expand internationally, including the acquisitions of Godrej Beverages and Foods in India and Van Houten in Singapore, as well as an agreement with Lotte Confectionery Co. to manufacture and sell chocolate products in China.^[5][6]

Rising costs are a particularly difficult challenge for Hershey. The company is vulnerable to market prices of key ingredients like cocoa, milk, sugar and peanuts, all of which saw price increases in 2009.^[7] In order to combat rising costs, the company has both lowered product weight and raised domestic wholesale prices. With the recent turmoil in the Ivory Coast, which produces 40% of the world's raw cocoa^[8], prices for this vital chocolate ingredient have risen more than 15% since November 2010. The long-term effect of the conflict on chocolate prices remains to be seen but it closely follows crop plagues in both Ghana and Indonesia which threatened the cocoa supply in mid-2010.^[9]

Company Overview

Hershey is a manufacturer of chocolate and other candy items, selling its products in over two million retail outlets in 50 different countries.^[2] Although Hershey has global reach, more than 90% of its revenue and profits come from the United States.^[2]

Business Financials

HSY Supply Chain Transformation Expenses by Category^[10]

In 2010, Hershey posted $5.67 billion in revenue, a 7% increase from 2009.^[11] Hershey implemented a cost-saving initiative in 2007, which when completed in 2010 should result in annual savings of $190 million.^[12]

The restructuring program has had a large impact on Hershey's net income, sending it up 47% in 2008 to $311 million.^[13] The increase is due to the success of the restructuring plan, increased advertising for the company's core brands, and higher prices introduced late in 2008. In 2010, Hershey recorded net income of $510 million.^[14]

Products

Hershey’s primarily makes cocoa for the production of chocolates, candies and other confectioneries. With 90% of its sales in North America^[15], Hershey's production facilities are primarily located in the U.S., Mexico and Canada. Beyond production, Hershey's offers its products through a variety of distribution channels including wholesale distributors, chain grocery stores, mass merchandisers, chain drug stores, vending companies, convenience stores, dollar stores and department stores^[16]. The McLane Company, distributor to Wal-Mart (WMT), is Hershey's largest customer, accounting for 27% of sales in 2009.^[17]. Hershey's offers products in several categories:

Chocolates:

• Hershey’s
• Reese’s'
• Hershey’s Kisses
• Milk Dud
• U.S. licensing of Nestle's Kit Kat

Premium Chocolates:

• Cacao Reserve
• Joseph Schmidt
• Dagoba

Refreshment products:

• Ice Breakers
• Breath Savers
• Bubble Yum

Trends and Forces

Growing Global Demand Makes International Expansion Attractive

Huge markets in China, India and other developing countries also present a big opportunity for Hershey's. Chocolate sales in China have doubled to $813 million over the last five years while India's chocolate sales have risen 64% over the same period^[18] Hershey's has tried to move into these markets with through joint ventures with Lotte Confectionery of South Korea and Godrej in India. Still, with 90% of sales within North America, international expansion remains a big opportunity.

In April 2010, Hershey's announced plans to open its first store in Singapore; it hopes to open six additional stores in the country within three years. The company is also investigating expansion opportunities in Indonesia, Malaysia, and Thailand, with each country eventually supporting four to six stores. In the Middle East, the company is looking to UAE, Kuwait, and Qatar as possible store locations with four to six stores in the UAE and two or three in the other two countries eventually.^[19] Although Hershey's bid for Cadbury was unsuccessful when Kraft Foods (KFT) purchased the UK-based chocolatier, the company is still looking to international markets for its growth prospects; the company has said they are interested in acquiring foreign candy companies in order to expand their global footprint.^[20]

Premium and Dark Chocolates are Fast Growing Segments

U.S. premium chocolate grew 129% from 2001 to 2006^[21]

Restructuring Initiative Promises Increased Savings

Hershey's lags behind its competitors in terms of operating margins. While traditional margins in the packaged food and Chocolate industry have been around 25 percent, Hershey's margins are below 20 percent.

In order to expand margins, in 2007 Hershey's began a $525-$575 million supply-chain restructuring plan. As part of its "Global Supply Chain Transformations" the company reduced production lines, outsourced the production of many of it's low value-added products and built a new cost effective facility in Mexico. The company expects to save $180 million annually by the completion of this plan in 2010. Hershey's claims the success of this initiative leads to greater manufacturing flexibility and allows the company to support its strategy to penetrate new markets^[26].

Competition

Hershey’s enjoys the largest share of the US Chocolate market and is the leader in both single-serve and bulk (boxes/large bars/bags) Chocolate products. Mars is Hershey's closest rival, owning well-known brands such as Mars, Snickers, M&M's, Milky Way and Twix. In April 2008, Mars announced the $23 billion acquisition of Wrigley. The deal creates a confectionery giant combining many stable brands with global distribution^[27].

The threat of competition in North America from powerful global confectionary companies such as Nestle (NSRGY) and Cadbury Schweppes (CSG) (now part of Kraft Foods (KFT)) is effectively mitigated through Hershey’s licensing agreements. In the case of Néstle, Hershey's owns exclusive US licensing rights to Kit Kat – one of Nestle's strongest brands. Without the Kit Kat platform it will be difficult for Nestle (NSRGY) to gain a competitive edge in the US market. Hershey’s also owns the US licensing rights to all the Cadbury Schweppes (CSG) brands, thus preventing Cadbury Schweppes (CSG) from entering the US market.

On January 19, 2010, Kraft Foods (KFT) bought Cadbury for $19.5 billion, outbidding Hershey to create the largest chocolate and confectionary company in the world. The merger hurts Hershey's international growth prospects as the company had been hoping Cadbury would greatly expand Hershey's brands beyond their current domestic marketplace. In the wake of the merger, rumors have circulated that Nestle (NSRGY) is looking to buy a smaller competitor such as H.J. Heinz Company (HNZ) or General Mills (GIS), and Hershey's name has also been mentioned. However, a spokesman for the Hershey Trust has categorically denied any possibility of a takeover.^[28] Despite the Trust's denial, rumors are still circulating about a possible takeover by Nestle, especially since the company's recent sale of Alcon to Novartis for $28.1 billion. With the new cash, Nestle could buy almost any food or confectionery business with cash; Hershey's shares were valued around $10 billion in August 2010.^[29]

Hershey's has a leading share in the U.S. chocolate market^[30]

References

1. ↑ Mars takes a bite out of chocolate giant Hershey.
2. ↑ ^{2.0 2.1 2.2 2.3} HSY 2007 10-K pg. 1  
3. ↑ HSY 2011 10K
4. ↑ HSY 2007 10-K pg. 3  
5. ↑ HSY 2007 10-K pg. 27  
6. ↑ Hershey to buy Van Houten Singapore consumer business from Barry Callebaut.
7. ↑ HSY 2009 10-K, Item 1: Business, p. 5
8. ↑ Could Ivory Coast turmoil make chocolate more expensive?, BBC, 12/22/10
9. ↑ Could Ivory Coast turmoil make chocolate more expensive?, BBC, 12/22/10
10. ↑ HSY 2007 10-K pg. 24  
11. ↑ HSY 2009 10-K, Item 6: Selected Financial Data, p. 18
12. ↑ Hershey sets restructuring plan, to cut 1,500 jobs.
13. ↑ Hershey 4Q profit rises partly on raised prices.
14. ↑ HSY 2011 10K
15. ↑ Hershey's 2007 10K- Item 1. Business- Reportable Segment
16. ↑ Hershey's 2007 10K- Item 1. Business- Customers
17. ↑ HSY 2009 10-K, Item 1: Business, p. 4
18. ↑ Motley Fool- Chocolate in Asia: A Very Sweet Megatrend
19. ↑ Hershey's Chocolate World makes foray into Singapore, Channel NewsAsia, 4/16/10
20. ↑ Hershey Plans 'Aggressive' Mergers, Pennlive.com, 5/11/10
21. ↑ Mintel U.S. Chocolate Confectionery Report
22. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
23. ↑ U.S. Chocolate Sales Forecast to Reach $18 Billion by 2011.
24. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
25. ↑ Boston Globe- U.S. dark chocolate sales soar on health benefits
26. ↑ Hershey's 2007 10-K Item 7. Management's Discussion- Business Realignment Initiatives
27. ↑ Mars to Buy Wrigley's for $23b.
28. ↑ Is Nestle Looking to Gobble Up Hershey?, Pennlive.com, 1/27/2010
29. ↑ Hershey Options Should Be Bought to Bet on Nestle Takeover, Capstone Says, Bloomberg, 8/13/10
30. ↑ Mintel U.S. Chocolate Confectionery Report