In retrospect, long-term owners of Hershey Co (NYSE:HSY) are likely wishing they’d taken the sweet buyout offer they got from Mondelez International Inc (NASDAQ:MDLZ) back in 2016. The rival candy and food company was willing to pay $107 per share of Hershey stock at the time. Now it’s trading at less than $97 per share while the broad market is much, much higher for the same timeframe.
Granted, it could be worse. On the other hand, between the 15% pullback Hershey’s stock has suffered since the end of last year and a recent downgrade of Hershey stock by a prominent analyst, things could certainly be a lot better too.
On balance, this confectioner looks like it could be give investors a toothache.
No Love for Hersey Stock
Had UBS analyst Steven Strycula not confirmed a couple of ideas that investors more or less already sensed, his recent downgrade of Hershey’s stock from “Neutral” to “Sell” may have been shrugged off. The analyst community isn’t exactly in love with the company right now.
But he hit a couple of major nails right on the head, when he said on Tuesday, “Hershey’s portfolio is over-exposed to slowing category consumption, intensifying competition, and rising cocoa prices.”
There’s ample proof of the chocolate pudding on all three fronts.
After a cocoa prices rose to uncomfortable multi-year highs in 2015 which lingered into 2016, chocolatiers got a much-needed reprieve last year when cocoa prices fell from above $3,000 per metric ton to less than $2,000 per metric ton. The candy business could be worth being in again.
It was a reprieve that wasn’t built to last though. Cocoa’s back to $2,500, and is testing the waters of higher highs. The glut driven by persistently high prices through 2016 is now abating, in spades.
Source: Trading Economics
Yet, while the supply is being whittled down — good for suppliers, not good for candy-makers — that drawdown isn’t entirely being realized for the reason Hershey would prefer.
Yes, there are certain health benefits to eating chocolate, and dark chocolate in particular. Consumers are finally digesting the fact, however, that avoiding chocolate along with other sugary foods altogether is an even healthier option. A 2016 survey performed by Leatherhead Food Research found that more than half of all Americans (where Hershey has to do well) are making a deliberate effort to consume less sugar.
It’s a paradigm shift that hits the company right in the breadbasket.
Stiff Competition for Hershey Stock
Hershey Co hasn’t simply stood back and done nothing while the headwinds blew against it. It’s created brand extensions like Hershey Gold — a candy bar without chocolate — and acquired non-candy outfits like Amplify Snack Brands (which makes SkinnyPop popcorn) and Krave Pure Foods, which makes jerky.
Those movers aren’t exactly the game-changers they need to be for the company, however. Popcorn is a rather competitive market already occupied by brand names like Campbell Soup Company (NYSE:CPB) name Pop Secret and Orville Redenbacher, a Conagra Brands Inc (NYSE:CAG) line. Both are market leaders and will be difficult to displace.
And even if Hershey finds success outside of candy, it still relies on candy for the bulk of its top and bottom lines. There’s a mountain of competition on that front, now fighting for fewer consumer dollars. The chocolate market is also only expected to grow at an annual pace of 2.5% through 2025. That’s just not enough upside.
Strycula added to his bearish thesis. “Our data analysis highlights increased US promotional activity in chocolate as vendors compete for distribution in a decelerating consumption category,” he said. His death blow? “These longer-tailed trends carry negative margin mix and potential distribution losses for Hershey.”
Bottom Line for Hershey Stock
The irony and frustration is Hershey isn’t a bad brand name, nor is it a poorly run company. A big chunk of its problems are circumstantial and beyond management’s control. On the flipside, fair or not, it’s up to Hershey to figure out the best way to play the hand it’s been dealt.
Whatever the case, Hershey’s road ahead looks a little too challenging for investors to bother taking the risk.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.