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The Science of Hitting
The Science of Hitting
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Hershey Q3 2011

November 01, 2011 | About:

Hershey (HSY), the leading producer of quality chocolate in North America, reported third quarter earnings last Thursday. Here are some of the highlights from the filing and the conference call:

Consolidated net sales were $1.62 billion compared with $1.55 billion in the third quarter of 2010, an increase of 5% year over year; this was driven by 5.4% of price realization, offset by a 1% decline in volume (with 0.6% in foreign exchange plugging the gap). Considering that the price increase was in the U.S., it is safe to assume that volume increases internationally offset a slightly larger volume decline (2-3%) in the States. For readers who have followed my articles, compare this to someone like Campbell’s Soup, which increased prices 3% in their Simple Meals category and was met with a double digit decline in volume as a result; that goes to highlight the strength that Hershey holds in the categories within which they compete.

Through the first nine months of the year, sales have increased 7.8% to $4.51 billion, compared to $4.19 billion through the third quarter in 2010. For the full year, the company expects sales to increase around 7%, including the impact from foreign exchange.

While the market has outpaced historical CMG (candy, mint, and gum) category growth rates of 3-4% (4.5% in the quarter, 4.4% year to date), part of the outperformance by Hershey can be explained by market share gains: in the channels measured by syndicated data, U.S. market share in the third quarter and year-to-date each increased 1%. As noted in the press release, this was driven by investments made in core brands, including in-store programming, merchandising and advertising.

Sales outside the U.S. continue to grow, with expected sales growth in Mexico, China, Brazil, and India (through a joint venture with Godrej) to collectively exceed 20% for the year; if this pace can be sustained, Hershey’s is on track to hit their 2015 goal of $1 billion plus in ex-North American sales.

Gross margins in the quarter were down 50 basis points as a percentage of sales to 41.9%; this is better than the 80 basis point decline year to date, with cost savings, productivity initiatives, and net price realization being outweighed by commodity cost inflation (something that we’ve heard over and over from CPG companies as of late).

Reported EPS in the quarter was $0.86, an increase of 8.9% compared to Q3 2010 ($0.79). In the company’s release, they reported an adjusted EPS of $0.84, which includes the following onetime items: pre-tax charges of $13.5 million ($0.03 per share) related to the Project Next Century program announced in June 2010, and a pre-tax gain of $17.0 million ($0.05 per share) on the sale of a non-core trademark license.

Through the first nine months, earnings were $2.12 per diluted share, an increase of more than 30% compared with the $1.63 per share earned through the first nine months of 2010. After backing out onetime items (2011 - $0.06 charge from Project Next Century, $0.05 gain on sale of trademark license; 2010 - $0.31 charge from Project Next Century), adjusted EPS has increased 9.8% year to date. For the full year, the company expects the adjusted EPS to increase “around ten percent”.

Looking ahead to next year, here is what CEO J.P. Bilbrey had to say:

“We expect the economic environment to remain challenging; however, we are well positioned to succeed in the marketplace. We’ll look to leverage our scale at retail in the U.S. and will work closely with our retail partners to ensure conversion is within our price elasticity modeling. We’ll also continue our disciplined build out and investment in go-to-market capabilities within key international markets. While we anticipate higher input costs in 2012, we’re very focused on adjusted gross margin. The previously announced pricing action and productivity and cost savings initiatives are in place to help mitigate the impact of increased commodity costs. While the spot prices of most key commodities have declined from their 2011 peaks, many are still trading at levels greater than the two-year average price. Therefore, we expect 2012 net sales, including the impact of foreign currency exchange rates, and adjusted earnings per share-diluted growth to be within the Company’s long-term 3-5% and 6-8% percent objectives, respectively.”

Based on that 6-8% increase and full year 2011 adjusted EPS estimates of $2.79-2.82, the guidance suggests 2012 EPS of $2.95-$3.04; at Tuesday’s close of $57.28 per share, the stock trades at roughly 19 times forward earnings estimates.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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