When Hershey Co. hiked prices by more than 10 per cent to offset rising ingredient costs, something unexpected happened: Candy lovers hardly blinked.
Hershey's unit volumes slipped just half a percentage point as most people continued to feed their cravings for Almond Joy bars, Jolly Rancher candies and BreathSavers mints. Driven by the combination of higher prices and resilient demand, Hershey's first-quarter sales and profit smashed expectations, sending the stock up sharply.
"Consumers don't really care what price they pay for a candy bar when they are paying $50 for a tank of gas," said Credit Suisse analyst Robert Moskow.
That's especially true for Hershey. Thanks to its stable of well-known brands, the inexpensive nature of its products and its roughly 30-per-cent share of the U.S. confectionery business, North America's largest chocolate maker enjoys pricing power that is the envy of other packaged food marketers. The low level of private label competition in the candy bar business is another big plus for the 118-year-old company.
Despite a challenging economic backdrop, Hershey's revenue has risen at an average annual clip of 4.2 per cent over the past five years, lifted by higher prices, new product launches and expansion in emerging markets, such as China, Brazil and India. Aided by cost-cutting – the company has closed underperforming plants, trimmed more than 10 per cent of its work force and outsourced some production – net income has grown at an even faster 10.7 per cent annually.
All of this has produced some sweet returns for shareholders. Over the past five years, Hershey's stock has delivered an annualized gain of 6.8 per cent, including reinvested dividends. That handily beats the S&P 500's annualized return, including dividends, of about 0.3 per cent over the same period.
Hershey's dividend yield of about 2.2 per cent may not satisfy everyone's craving for income, but the company has a long track record of raising its dividend annually (with the exception of the 2008-09 financial crisis). Including a 10-per-cent hike in February, the dividend has risen 150 per cent in the past decade and there are almost certainly more increases on the way, given Hershey's strong free cash flow generation.
"We're very much committed to the dividend. We think that's a good way to give back to shareholders," Bert Alfonso, Hershey's chief financial officer, said on the first-quarter conference call.
To be sure, the stock isn't cheap. Trading at a multiple of about 21 times 2012 earnings estimates, the shares are implying that Hershey will continue delivering the goods. But if profit comes in weaker than expected, investors could wind up with a chocolaty mess on their fingers.
The rich valuation explains why 10 of the 17 analysts who follow the company rate it a "hold," with seven "buys" and no "sells." The average price target for the next 12 to 18 months is $69.42 (U.S.) – a 2.5-per-cent premium to Tuesday's close of $67.74.
Edward Jones analyst Jack Russo said Hershey has a lot going for it, including a strong new product pipeline and expected growth of more than 20 per cent in emerging markets this year. Yet he doesn't recommend buying the stock at current levels. "Hershey shares are now trading at a large premium to other packaged foods stocks, leading us to believe the stock is appropriately priced."
Mr. Moskow of Credit Suisse is more upbeat. He rates the stock a "buy" with a price target of $75, and says there are "more treats to come."
In a note following the release of the first-quarter numbers in April, he said Hershey's gross margins are poised to benefit now that cocoa prices have come down sharply. The improvement won't be felt immediately because Hershey locked in many of its ingredient costs, but as those hedges expire and the company maintains its candy prices at higher levels, gross margin could expand at least 2.3 percentage points in 2012, he said. That's more than double management's estimate of up to a one-percentage-point increase, a forecast he called "too conservative."
"If this were any other food category, we would be concerned about a price rollback," he said. But "with the No. 2 competitor, Mars, happy to act as a price follower in the U.S., the risk of a price rollback is minimal."
Consumers have been paying more for Hershey's products. And if Mr. Moskow is right, investors could also soon be paying more for its stock.