When Milton S. Hershey returned back to his home state of Pennsylvania in 1886 after several failed business ventures, he had no idea he would end up laying the foundation of a confectionery business that would be thriving 100+ years later. Mr. Hershey had decided to focus on making chocolate after trying his luck as a candymaker and caramel manufacturer. By experimenting with chocolate bars and chocolate-covered caramels, Hershey finally made enough money to open his own factory after years of struggle. In 1903, Milton Hershey broke ground for the Hershey chocolate factory on Chocolate Avenue in Hershey, PA.

Today, Hershey is a ~49 billion dollar company with a portfolio of household names such as Hershey’s Kisses, Reese’s, Kit Kat, Jolly Rancher, SkinnyPop and Dot’s Homestyle Pretzels. In 120 years, Hershey has progressed from being a producer of chocolate to envisioning a future as a “snacking powerhouse,” in the company’s own words.

Per Statista, Hershey is the leader in the U.S. confectionery industry with a market share of 33.5% just ahead of Mars (M&M's, Snickers and more). Hershey's market share has grown from 31% in 2016 and 29% in 2011. However, Hershey’s confectionery business is a mature, fairly slow-growing segment (4.1% CAGR from 2017 to 2021). The fastest growing part of the company is the snacking segment, an area which Hershey has ramped up its investments over the past decade.

At the last Investor Day in 2017, Hershey outlined the opportunity that exists in the snacking category based on changing consumer trends, "global snacking is a ~$1 trillion opportunity." To account for the increased emphasis on snacking, Hershey recently started to report its operations in three segments; North America Confectionary, North America Salty Snacks, and International. Previously, all operations in North America were reported under the same segment.

(Numbers from Hershey 10-Q for 4Q22)

The data for the North America Salty Snacks segment only goes back to 2019. Back then, the segment did $410 million in revenue (~5% of total revenue). Fast forward to the end of fiscal year 2022 and the same segment has surpassed $1 billion in annual revenue, now representing a meaningful 10% of Hershey’s total revenue. Most of the growth is non-organic (the 2021 acquisitions of the snack manufacturer Pretzels as well as Dot’s Pretzels were big contributors). The increased investments in snacking has provided good results for Hershey so far which makes it reasonable to think that we will see more acquisitions in the future.

The scheduled Investor Day on March 22 will likely provide an update on Hershey’s market share and what investors can expect of the different segments going forward.

The snapshot of Hershey’s financials is a good way to represent the pricing power of the business. Despite slow revenue growth, operating income grew at a faster rate and EPS increased at double-digits annually over the past 5 years.

“North America Confectionery segment income was $703.5 million in the fourth quarter of 2022, reflecting an increase of 12.9% versus the prior-year period. This resulted in segment margin of 32.3%, an increase of 90 basis points. Net price realization, volume gains and media cost efficiencies more than offset broad-based inflation, increased manufacturing and labor costs, and higher levels of brand and capability investments to drive segment income and margin expansion in the fourth quarter.”

Total revenue growth of 16.0% for the year (and 14.0% for the quarter) is impressive for a mature company. The ability to pass on inflation to the consumers while maintaining volumes shows the resilience of Hershey in difficult economic environments. In fact, volumes were also up 2.8% for the confectionary business and 4% overall in 2022. This level of pricing power is likely the reason Hershey and a select group of consumer staples have performed so well over the past year. In hindsight, Hershey was perhaps an obvious “flight to safety” in a time where high inflation was expected. The durability of Hershey’s business is matched by few others.

Hershey has also consistently generated high Returns on Capital Employed (ROCE) along with the continued reinvestments in its business.

After almost a decade of slow growth, Hershey seems to have been successful with its transition into the snacking market - at least if you judge by the numbers. I also think inflation arguably has been positive for Hershey because it has provided an opportunity to increase prices without much pushback. Even though there is heavy competition in candy, chocolate and snacks, the pricing pressure has been minimal because competitors have faced similar increases in input costs and consequently raised prices as well.

Just a quick note on debt - which could be relevant if we continue to see acquistions as Hershey continues to move into snacking. At the end of FY22 Hershey had ~$4.3B in net debt and about 17x EBIT/Interest Expense. Given the stable cash flows there is likely room to finance future deals with more debt as well.

Hershey arguably doesn’t scream value at the current valuation of ~30x trailing P/E and ~30x 2023e free cash flow. Below is my basic financial model of Hershey’s future free cash flows with the assumptions of 12% FCF growth over the next 5 years, conservative share repurchases and a similar dividend growth rate we have seen the past few years.

I also played around with a reverse DCF (https://tradebrains.in/dcf-calculator/) to see what growth rates the current share prices implies. Let me explain: the current share price of ~$239 implies a fairly high free cash flow growth over the next 10 years. If you think a terminal 20x FCF multiple is fair, then the implied growth is somewhere close to a 12% CAGR over the next decade. Similarly, if you assume a 25x terminal multiple, the current stock price implies an annual average FCF growth of about 10%.

This assumes a 10% discount rate and share repurchases are not accounted for. For what it's worth, I think this exercise helps us think about what sort of margin of safety we find in today's stock price. It's fair to say that the current price reflects an optimistim around Hershey's future.

Over the past 1-2 years, the stock market has increasingly put stronger emphasis on profitability, predictability and consistency in earnings. Hershey’s 1-year return is about ~17% compared to the S&P 500 which is in negative territory over the same time frame. We have seen a similar “flight to safety” in other consumer staples such as Procter & Gamble, PepsiCo and Walmart, among others, which are all near all-time highs. While Hershey might not provide spectacular returns over the next years at the current valuation, there is no doubt to that Hershey stock is an excellent defensive pick - very much a coffee-can portfolio type of company with growing dividends and a solid track record. The last years have also shown that Hershey still has plenty of room to grow.

Hershey is not part of my portfolio as of today but I remain an avid fan of the company and I will happily be following along as the company embarks on its journey to becoming a “snacking powerhouse."

Thanks for reading!