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With Dipping Cocoa Prices, Will Hershey Make a Sweet Choice?

Zacks Equity Research

The time is ripe for picking chocolate stocks as cocoa prices continue to melt down. This is primarily due to copious supply and fading demand, as growing health consciousness continues to grip consumers. As per a recent Bernstein research, the price of cocoa has plunged 37% since last summer and is expected to trickle down for the next few years.

This makes The Hershey Company HSY, the largest chocolate manufacturer in North America as well as a global leader in chocolate and non-chocolate confectionery, a special treat for chocolate investors.

Analyst Alexia Howard of Bernstein stated, “Easing cocoa prices could be a major tailwind as we move out into 2018, more than offsetting the relatively mild inflation in dairy prices.” This is assuming that cocoa comprises an estimated 10% to 15% of Hershey’s cost of goods sold or COGS. Also, considering that cocoa will account for 10% of Hershey COGS, Howard's estimates a 30% decline in input prices, which in turn is likely to boost gross margin to 47.8% from 46.2% in a year, thereby lifting earnings per share by 8.6% or 42 cents.

Moreover, Howard’s thesis is backed by the U.S. chocolate industry’s growth prospects driven by the snacking trends among millennials and more product innovation, as Mondelez International Inc. MDLZ increased its competition.

What Hershey’s Q2 Numbers Have to Say

Hershey’s second-quarter 2017 earnings per share improved from the year-ago profit level by 28.2%, driven by higher sales, solid gross margin expansion and operating income improvement in the International segment.

More precisely, the company’s adjusted gross margin expanded 160 basis points (bps) to 47.1%. The company stressed that this upside was driven by supply chain productivity, cost-saving initiatives and lower input costs. For the full year, the chocolate maker also expects adjusted gross margin to rise about 50 bps, buoyed by lower input costs (higher than earlier anticipated) and by productivity and cost-savings initiatives. These positives is likely to offset fixed costs volume absorption due to lower sales, unfavorable product mix and the rollout of new packaging formats.

It is to be borne in mind, Hershey has been reporting weak top-line growth for the last few years due to persistent macroeconomic challenges in China as well as a shift in consumer preference toward products with less artificial sweeteners, sodium and saturated fat. As a result, Hershey, like a number of U.S. food producers such as Mondelez, B&G Foods, Inc. BGS and General Mills, Inc. GIS, has been grappling with declining demand.

That said, the company’s net sales improved 1.5% year over year in the second quarter owing to strong performance by the North America segment and the acquisition of barkTHINS brand. This marks the fifth straight quarter of sales rise after a few quarters of no growth.

Again, adjusted operating profit increased about 16.9% from the year-ago period, resulting in operating profit margin of 20.8%, an increase of 270 basis points. The increase was driven by higher gross profit and lower SG&A due to productivity and cost savings.

Other Relevant Metrics

Hershey’s shares have gained 1.7% so far this year compared with the industry’s decline of 22.5%. Estimates for 2017 and 2018 have remained stable over the last 30 days. Hershey has been able to beat earnings estimates in each of the trailing four quarters, resulting in an average positive surprise of 10.35%. The company’s productivity improvements and cost-saving initiatives should drive the stock’s performance in the upcoming quarters as well.

Moreover, sales and earnings for the current year is expected to increase nearly 1.1% and 8.9%, respectively. This top-line as well as bottom-line performance is reflected in the growth style score ranked B. Overall, Hershey has a VGM Score of B.

Hershey’s ROE of 119.7% compared with the industry average of 9.7% manifests the company’s efficiency in utilizing shareholder’s funds. Again, based on last day's closing price of $105.16 per share, the company's current dividend yield is 2.49%, a lot higher than the industry’s 0.00%.

Hence, this Zacks Rank #3 (Hold) company has good prospects and is expected to make value addition to your portfolio. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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