The hardest decision an investor often has to make involves their best-performing stocks. Finding companies that consistently outperform the S&P 500 (SPY) and the broader indexes is hard, and knowing when the investment is no longer good value is almost always difficult.
The Hershey Company (NYSE:HSY) was one of the top-performing stocks in the market for some time.
The leading chocolate maker was up 3,057% over nearly the last 30 years as measured by total returns, while the S&P 500 was up 1,866% using total returns during the same time period.
Still, Hershey’s has struggled recently for some time.
The stock is down nearly 28% using total returns over the last year, and Hershey’s is also essentially flat over the last 2 years, while the S&P 500 is up nearly 13% since early 2022.
I last wrote about Hershey’s in August 2023, and I rated the stock a sell primarily because of my view that the company was relying on unsustainable price increases to drive only modest growth. I am now downgrading the company to strong sell. Chocolate prices continue to rise, and the company’s recent earnings reports show that management has no plan to drive significant growth moving forward. The stock now looks significantly overvalued at the current price using several metrics.
Hershey’s reported fourth quarter earnings per share GAAP actual of $1.70 a share and revenues of $2.66 billion. The company missed on both the top and bottom line since consensus analyst estimates were for EPS GAAP actual of $1.89 a share and revenues of nearly $2.72 billion. The corporation’s quarterly statement also contained several points that should concern shareholders. Even though management reported that for the full year, consolidated net sales rose 7.2%, net income rose 13.8%, and earnings per share rose 12.6%, the chocolate maker’s fourth quarter was one of the company’s worst operating performances in some time. The company also issued very tepid guidance. Hershey’s reported that compared to the fourth quarter in 2022, consolidated net sales growth for the fourth quarter in 2023 grew by just .2%, and net income fell 11.5%, and adjusted earnings growth per share-diluted was flat. Management’s guidance was for just 2-3% net sales growth in 2024, and essentially 0% earnings per share growth as well.
Hershey’s raised prices by 14% in 2022 alone, and management has increased prices by 20% in the last 2 years combined. Still, the company’s bad fourth quarter and poor guidance for the upcoming year show that management doesn’t have the pricing power to continue to pass on escalating costs. Even though the chocolate maker recently announced layoffs and plans to cut $300 million in costs, the company is still planning to spend nearly $650 million this year on a variety of administrative upgrades, including focusing on making the company’s sales platform more digital. Hershey’s quarterly growth rate has declined in 5 of the last 6 quarters.
Hershey’s has a market share of nearly 45% as the North American chocolate industry looks to be at a point of saturation. The company’s best opportunities for growth are in international sales in the salty snacks business. This is why investors should be particularly alarmed by the company’s recent struggles in the salty snacks division. Management reported a 24% decline in net sales in the US salty snack division, with some of the company’s key brands in areas such as ready to make Popcorn struggling the most. Hershey’s also continues to struggle to drive any substantive growth overseas. While the company reported 11.2% growth internationally, the chocolate maker is getting just around 10% of overall revenues from outside of North America.
The margin compression that Hershey’s saw in the fourth quarter is also important because the price of chocolate continues to rise significantly for multiple reasons.
Chocolate prices recently hit record highs in the last week of March primarily because of weather-related issues, and sugar prices are already up 8% in 2024 after being up just 2.7% in 2023. Several new studies are also suggesting that these high prices are likely to remain for some time, primarily because of production issues, crop disease, and weather issues. Hershey is already dealing with rising administrative costs and increasing wages as well.
This is why the stock now looks significantly overvalued at 19.72x forecasted forward GAAP earnings and 3.30x predicted future sales. While the company’s 5-year average valuation is 25.23x projected forward GAAP earnings and 4.01x expected forward sales, Hershey’s growth rate has stagnated from past levels. Analysts are expecting the chocolate maker to grow earnings at just 4% per year over the next 4 years.
The company’s price-to-earnings ratio is likely to regress closer to the sector average, and the sector median valuation is 17.94x expected forward GAAP earnings and just 1.17x projected forward sales. While the company should still command a premium to the industry average because of the strength of the chocolate maker’s brands, the P/E should still contract.
Any investment thesis has risks, and if Chocolate prices were to fall significantly, management was able to stretch out operating expenses by dramatically cutting costs, or the company was successfully able to put in another large price increase, the Chocolate maker could likely see some modest growth this year. If the overall macroeconomy were to recover and if inflation rates were to fall and interest rates came down, Hershey’s would obviously benefit from those factors as well. Still, these scenarios remain unlikely.
Hershey’s was one of the best-performing stocks for some time, but management has no plan to grow core businesses in North America or build on the company’s alternative product lines in the US or abroad. The chocolate maker’s market share has likely reached a point of Saturation in the US and Canada, and the leaders of this company don’t have a plan to drive meaningful growth outside these markets. With costs rising and growth stagnating, investors should be able to find better value in other investments.
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