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This Downgrade Is the Least of the Bad News for Hershey Co Stock

Without impulse purchases, Hershey stock is in trouble

Hershey stock - This Downgrade Is the Least of the Bad News for Hershey Co Stock

Source: mhiguera via Flickr

The downgrade of Hershey Co (NYSE:HSY) by Credit Suisse AG (NASDAQ:TVIX) has attracted attention. Analyst Robert Moskow downgraded Hershey stock. Now, as it faces analyst skepticism, Hershey must find a way to grow as one of its sales strategies becomes less viable.

Unfortunately for Hershey stockholders, its sales issues face more significant challenges than the lowered opportunity for impulse buys.

Hershey Stock and the Downgrade

In his report, Moskow downgraded HSY stock from neutral to underperform. He also reduced the price target on HSY from $90 to $80 per share. However, given the competition Hershey’s now faces, the stock could fall well below the $80 per share price target.

To be sure, the impulse buys that Credit Suisse cite in their report make up a large portion of sales. For decades, Hershey’s and its peers have relied on impulse purchases as customers waited in line to pay for their items. The popularity of, Inc. (NASDAQ:AMZN) has reduced the opportunity to profit from this sales strategy.

Determining whether Moskow set a fair price target remains a matter of perspective. Analysts forecast a profit growth rate of about 12% for this year. Currently, its price to earnings (PE) stands at 18.25. This takes its price-to-earnings-to-growth (PEG) ratio to over 1.5. From this perspective, I think $80 stands as a fair price target.

However, revenue growth has stagnated over the last four years. Moreover, profit estimates have consistently come down over the last few months. If growth estimates do not hold up, the PEG ratio will spike. This could send the price of HSY stock well below $80 per share.

E-commerce Exposed Hershey’s Moat

Unfortunately, the reason for reduced profits probably lies in their lack of a competitive moat. Any moat Hershey enjoys does not extend beyond their name and their control of shelf space in brick-and-mortar retail. Like Kraft Heinz Co (NYSE:KHC) in the food space and Procter & Gamble Co (NYSE:PG) with their household products, HSY built its business on control of shelf space in traditional stores.

Like Heinz Ketchup or Procter & Gamble’s Bounty paper towels, Hershey’s chocolate possesses few profound qualities beyond its name recognition. Without the shelf space advantage, countless numbers of small chocolatiers can now set up a Shopify Inc (NYSE:SHOP) and compete with Hershey’s.

Competition has also become a more significant issue within brick-and-mortar retailing. Stores such as Whole Foods sell dozens of varieties of organic chocolate. On the low end, Aldi sells low-priced chocolates, some of which have received favorable reviews.

Perhaps HSY can take a page from the playbook of See’s Candies, a company owned by Warren Buffett’s Berkshire Hathaway, Inc. (NYSE:BRK.A, NYSE:BRK.B). See’s sells online and gives away over 1 million pounds of free samples per year at its stores. Whether Hershey’s can employ such a strategy remains unclear. However, the days where shelf space alone could drive sales increases have come to an end.

The Bottom Kine on Hershey Stock

Amid a downgrade, Hershey faces more significant challenges than Credit Suisse reported when it downgraded Hershey’s. The investment bank downgraded Hershey’s because of the reduced opportunity to profit from impulse buys. However, other competitive factors could take the stock well below the $80 per share Credit Suisse had predicted.

Online shopping reduces the ability to sell via impulse purchases. However, the more profound impact may come from smaller chocolatiers who can more effectively compete against Hershey’s no-moat products through online sales. Moreover, many of these products have made it on to store shelves in stores such as Whole Foods or Aldi, further marginalizing Hershey’s chocolate.

People will still shop in stores. For that reason, I predict Hershey’s will remain in business. However, the increased competition will reduce its sales. As a result, investors should prepare for the day when Hershey stock trades well below $80 per share.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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