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Hershey Foods (HSY)Stock (Confectioners Industry, Consumer Products Industry, Food Industry)
The Hershey Company (NYSE: HSY), commonly known as Hershey’s, is a leading manufacturer and distributor of chocolate and confectionary products operating mainly in the United States, Canada and Mexico. The company owns over 50 major brands including Hershey's, Reese's, Hershey's Kisses, Almond Joy, Mounds, York, Jolly Rancher, Twizzlers, Ice Breakers, and Bubble Yum. Hershey’s generated revenues of $4.95 billion in 2007 with net income of $214 million. Almost 90 percent of Hershey's revenues come from North America. In this market Hershey's is the largest player and has a powerful brand image. Since the US market for chocolate is quite saturated, Hershey's has embarked upon a strategy to gain share in the premium and dark chocolate segments. These segments have traditionally enjoyed higher margins and thus a successful penetration strategy should lead to greater profitability for the company. The Dark Chocolate segment is also growing rapidly due to increased demand from older Americans. In January 2007, Hershey’s announced a strategic alliance with Lotte Confectionary Co., a powerful Korean manufacturer with sales over $1.1 billion, to market and distribute products in US and Asia. As a part of the deal, Hershey’s and Lotte formed an $80 million joint venture to construct a manufacturing facility in China. Products from this facility are expected to hit the markets by August. In April 2007, Hershey's announced a similar joint venture deal with an Indian company, Godrej Beverages and Food Ltd. These deals are likely to increase Hershey's reach into mostly untapped Indian and Chinese chocolate markets.
[edit] History In 1894, Milton S. Hershey founded the Hershey Chocolate Company as a subsidiary of his Lancaster Caramel Company. In 1900, he sold the prosperous Lancaster Caramel Company but retained the chocolate business. He used the proceeds from the sale to acquire almost 40,000 acres of land northwest of Lancaster, Pennsylvania with a vision to create a community based around chocolate production. In 1905, Hershey completed his factory which was designed to mass produce chocolates. The Hershey’s chocolate bar became the first nationally marketed product of its kind and put the company on track for success. The next product, Hershey’s Kisses, introduced in 1907, went on to become one of the most successful and well-known products ever produced by the company. The Hershey Chocolate Corporation went public in 1927 and since then has grown both organically and through mergers and acquisitions, most notably that of Reese’s in 1963. The corporation changed its name to Hershey Foods Corp. in 1968 and finally to The Hershey Company in 2005. The Hershey Trust Company inherited the most of Milton Hershey’s assets including the majority of voting rights in the Hershey Chocolate Corporation. To this day, the trust controls 79 percent of the voting rights and has 31 percent ownership of Hershey's. Efforts to sell off its holdings in 2002 generated strong resistance and led to the forced resignation of 10 out of 17 Trustees. In the Hershey's latest controversy, the Trust forced the resignation of eight of Hershey's ten board members due to sagging profits and disagreements with the company's managing team. [edit] Product and Geographic mixHershey’s produces and distributes a wide range of well-known chocolate, gum, and candy products such as Hershey’s, Reese’s, Jolly Rancher, York, Hershey’s Kisses, Twizzlers, Ice Breakers, Bubble Yum and Milk Dud. Hershey's also holds the license to distribute all Cadbury products in the US and the exclusive US licensing rights to Kit Kat, a leading Néstle brand. A variety of premium chocolate products such as Cacao Reserve, Joseph Schmidt and Dagoba are sold through a wholly-owned subsidiary called Artisan Confections Company. Chocolate confectionary products account for roughly 73 percent of Hershey's revenues. In addition, Hershey's produces food and beverage enhancers under the Hershey’s, Reese’s, Heath and Scharffen Berger brands. The company also produces and distributes a range of snack products such as cookies, nuts, rice and marshmallow bars, and granola bars under several brands, most notably Hershey's and Reese's. Though Hershey’s products are sold in over 90 countries, sales outside of North America account for slightly over 10 percent of total revenues. Hershey’s recent joint venture with Lotte Confectionary Co., South Korea’s largest confectionary company, is likely to increase Hershey’s global reach. [edit] Trends and Forces[edit] Market TrendsDue to healthier eating habits the chocolate industry as a whole has been experiencing slow growth in the US. However, dark chocolates are gaining popularity due to their antioxidant properties. The solid dark chocolate segment is growing at almost 50 percent rate per year and Dark Chocolate penetration is increasing very quickly among older Americans (45+ age), who constitutes a third of the total population and account for 50 percent of the spending power. Moreover, census data suggests that older Americans are also the fastest growing age group. Hershey’s enjoys a dominant position in this segment with 60 percent market share.  Overall, the US chocolate market is saturated and Hershey's has to look for new avenues of growth. The recent acquisition of several premium brands suggests that the management is looking to focus on the higher margin premium product category. On the other hand, improved standards on living in India and China should lead to a surge in demand for chocolate products in these countries. Hershey's joint ventures with Lotte and Godrej will allow the company to take advantage of these new markets. [edit] Commodity cost inflationGiven that cocoa sugar and milk are key ingredients in chocolate making, any spike in their price exerts downwards pressure on Hershey's margins. During the most recent quarter, for example, Hershey's reported growth margins had decreased 2.2% due to higher commodity costs. Higher input prices do not translate to higher product prices immediately; company data suggests that there is a 15 month lag. Hershey's tries to minimize its risk from commodity prices through various hedging strategies. In fact in 2006, Hershey's had locked in the entire year's prices as early as April. It is worthwhile to note that Hershey's has a proficient hedging operation, having beaten the market for the last five years. Despite its successful hedging strategies, Hershey has not been immunized from commodity cost inflation, in the most recent quarter, company CEO Richard Lenny identified higher commodity costs, primarily dairy, as a prime cause for a 66% decrease in profits. [edit] Cadbury Schweppes (CSG) demergerCadbury Schweppes (CSG) is currently one of the world's largest confectionary and beverage companies, generating over $14B in revenues in FY 2006. In 2007, under pressure from activist investor Nelson Peltz, Cadbury announced that it would split its business into two separate companies, one focusing on beverages and the other on candy and confectioneries. Cadbury's confectioneries include:
Many, including analysts and Cadbury's CEO, see huge potential in a combination of Hershey and Cadbury's confectionery business. A merger of the two businesses may jump start growth at Hershey through a larger exposure to international, emerging markets while improving efficiencies at Cadbury. The single largest obstacle to any deal between the two companies is the Hershey Trust, which is unlikely to pursue any deal that dilutes Herhsey's earnings per share or forces them to relinquish their controlling stake in the company. [edit] Key Internal Drivers[edit] Marketing, Advertising and DistributionIn recent years Hershey’s has consistently reduced its advertising spending. To be exact, its advertising budget declined from 3.8 percent of gross sales in 2001 to 2.3 percent in 2005. During the same period, both Mars and Néstle have increased their advertising budgets aggressively. The graph below shows Hershey’s advertising spending as a percentage of the advertising spending in the whole industry. During the same period Hershey’s has increased its market share. Hershey’s achieved this through introduction of new products and by placing a greater emphasis on sales promotions. Due to the high-impulse nature of confectionary sales and consumers’ desire for new products this strategy has worked well for the company. However, it is unlikely that Hershey’s can continue to decrease its advertising budget indefinitely.  Unlike most of its competitors, Hershey’s maintains its own salesforce and distribution network in North America. The company is able to manage and negotiate deals directly with retailers. This has also allowed Hershey’s to enter into strategic agreements with international confectionary manufactures such as Lotte and Cadbury. However, business with Wal Mart, which accounts for 25 percent of Hershey’s sales, is managed by a wholesale distributor called McLane Company. [edit] Restructuring InitiativeHershey's lags behind its competitors in terms of pre-tax margin. While traditional margins in the packaged food and chocolate industry have been around 25 percent, Hershey's margins are close to 20 percent. Hershey's, therefore, has room for improvement. Hershey's recently announced a $500 million supply-chain restructuring plan. The company expects to save $180 million annually by 2010 if this plan is implemented properly. Hershey's has indicated that this initiative would lead to greater manufacturing flexibility and allow the company to support its strategy to penetrate into new markets. [edit] CompetitionHershey’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. The single-serve segment, defined as products which weigh less that 3.5 oz, has higher margins and account for 20 percent of the overall chocolate market. The bulk segment accounts for another 48 percent. Hershey’s has a market share of 47 percent in both segments. Its closest competitor in the US market is Masterfoods (Mars), which owns well-known brands such as Mars, Snickers, M&M's, Milky Way and Twix. Néstle is third in both segments.  Several observers have noted that both Néstle and Mars have become more aggressive in recent years. Both of these companies have increased their spending on advertising and introduced new products; however, there is no clear indication that their campaigns have been successful. Perhaps, the greater threat for Hershey's is cannibalization of its established products by its new products. Hershey’s recently acquired the brands Joseph Schmidt (November 2005) and Dagoba (November 2006). This move reflects Hershey’s plan to expand into premium chocolates, i.e. chocolates which sell for more than $7 per pound. This also puts Hershey’s into head-to-head competition with brands such as Toblerone, Ferrero Rocher and Lindt. Currently, Hershey’s has a 5 percent share of this segment. Premium chocolates enjoy higher margins than basic items. Continued growth in this segment should postively affect Hershey's gross margins. The threat of competition in North America from powerful global confectionary companies such as Néstle and Cadbury Schweppes 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 Néstle strongest brands. Without the Kit Kat platform it will be difficult for Néstle to gain a competitive edge in the US market. Hershey’s also owns the US licensing rights to all the Cadbury brands thus preventing Cadbury from entering the US market. Nevertheless, both Cadbury and Néstle will make it difficult for Hershey’s to make forays into other markets, notably in Asia.
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