The bear and bull case for Hershey
In Friday's e-mail, I examined the financials of chocolate and candy icon Hershey (HSY) at the request of many of my readers.
I concluded that the company is a great, recession-resistant business with a stellar track record. But the headwinds it's currently facing raise some inevitable questions:
Is this business fundamentally broken and in decline, in which case its stock is a value trap?
Or is the market overreacting to short-term issues that will go away – thus making the stock a buy?
Let's start with the former, which is articulated well in two Substack posts by Edwin Dorsey of The Bear Cave. In the first, from July 2023, Problems at Hershey, he highlighted a new competitive threat:
Today, Hershey faces rapidly growing competition from one of the world's youngest, most talented, and most influential entrepreneurs: 25-year-old YouTube star Jimmy Donaldson, AKA MrBeast. His new chocolate brand, Feastables, has waged an all-out war against Hershey in retail and on social media – and is winning. The Bear Cave believes Feastables rapid growth will soon take a major bite out of Hershey's profits.
In a follow-up post in March 2024, More Problems at Hershey, Dorsey wrote:
Since [my last post], Hershey stock has fallen ~20% and The Bear Cave is more confident than ever that Feastables is taking share from Hershey. In short, Hershey is a melting giant...
And although the exact numbers may be fuzzy, it's clear Feastables has grown sales rapidly from $0 in January 2022 to ~$30 million per year in May 2022, to "a couple hundred million" in September 2023, to ~$400 to $500 million per year today.
Feastables is showing no signs of stopping in its quest to fight Hershey.
Since that post, HSY is down another 17%. So Dorsey's warnings have been prescient so far...
In addition to rising competition from Feastables, investors are concerned that the new weight-loss drugs like Novo Nordisk's (NVO) Ozempic and Eli Lilly's (LLY) Mounjaro will result in tens of millions of Americans eating less food, especially sugary and salty snacks like those Hershey makes.
Lastly, Hershey has been affected by the rising cost of its primary raw ingredient, cocoa. Around 60% of the world's supply comes from two adjacent African countries, Ghana and Ivory Coast, which experienced heavy rains that wiped out a substantial fraction of their production.
This has led to a surge in price, as you can see in this five-year chart from Trading Economics:
All three of these headwinds could affect Hershey for many years. So what's the bull case for the company?
To answer this, I turned to Stansberry Research analyst Mike DiBiase, who writes:
Hershey is the oldest open recommendation in Stansberry's Investment Advisory. Our founder, Porter Stansberry, recommended Hershey in December 2007, calling it "our best 'no-risk' opportunity ever."
In that issue, Porter discussed the concept of "capital efficiency." Capital efficiency is an attribute that few companies possess... the ability to generate large and growing free cash flow ("FCF") margins over time, in turn allowing it to return more and more of its cash each year to shareholders in the form of dividends and share repurchases. It's why capital-efficient companies produce market-beating returns.
Hershey has all of these qualities. And on top of that, it owns a world-class brand and sells products adored by its consumers. It's almost certain that our great-grandkids will devour Hershey's chocolate.
As Mike continues, the stock has had impressive returns despite the headwinds:
Since that 2007 recommendation, the stock has returned 434%, including dividends, beating the S&P 500 Index's 364% return. Investors who bought the stock back in 2007 have now received more in dividends ($46.50) than they paid for the stock ($40) (both split-adjusted numbers). The investment is now truly risk-free.
Those market-beating returns are even more impressive when you consider the fact that Hershey's stock is down nearly 40% since May 2023. Meanwhile, the market is up 50% over the same span. It's the biggest drawdown since recommending the stock.
Investors are worried about historically high cocoa prices – which nearly tripled in 2024. But the supply shortages that led to record cocoa prices won't last forever. And Hershey is still a fantastic business. Despite soaring cocoa prices, Hershey produced $1.9 billion in FCF last year (a 17% FCF margin) and returned more than 80% of that cash to shareholders.
The recent pullback makes today a great time to buy shares if you don't own the stock. This is a company we want to hold forever.
I agree with Mike. The headwinds Hershey faces are well known and, I believe, reflected in the stock price. That gives investors the opportunity to own one of the greatest, most capital-efficient businesses in the world at a discounted price.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.
P.P.S. Following up on Thursday's e-mail... my college buddy Bill Ackman of Pershing Square has gotten a lot of flak for entering the doubles draw last week at the Hall of Fame Open tennis tournament in Newport, Rhode Island. He's an amateur and was on the court with three pros – and it showed. But he's taking it in stride, even posting a link to this really funny and clever video on social platform X:
