How Hershey Can Be Your Golden Ticket for Evaluating Investment Opportunities
Part 1: Analyzing Hershey's Business
I am excited to share my first post on Quartest covering a business with over a century of expertise that has established itself as a global leader in the snacking industry. Renowned for its iconic brands, this company has captured the hearts of consumers worldwide. With a mission statement of bringing sweet moments of happiness to the world every day, Hershey has solidified its place as a global confectionery leader and emerging snacking powerhouse. However, its place as a business leader extends much farther than the store shelves. Hershey’s historic financial performance, superior strategic positioning, and strong competitive advantages over its 100+ year history have allowed it to become a compounding machine that can and should be used as the ultimate comparative tool for investors when evaluating any investment opportunity.
Before diving too deep into the 100+ year history of Hershey, I would instead direct your attention toward the wonderful audio series, Hershey vs Mars on the Business Wars podcast, by Wondery. This 7-episode audio series masterfully lays out the fascinating history of Hershey’s confectionery business much better than I would ever be able to, so please listen to these episodes when you have the chance. I promise it is worth your time.
However, I didn’t write up this post simply to redirect you to a podcast. I just made the bold claim that Hershey can be used as the “ultimate comparative tool for investors” when considering the opportunity cost of investing in anything from a high-yield savings account to an index fund. This requires some serious evidence and a strong explanation, so that is exactly what I intend to do.
The quality of a business is the most important factor in determining its long-term success.
While short-term fluctuations in investor sentiment, and market conditions can affect the price of stocks and valuations of companies, the durability of a business and its capacity to produce consistent and meaningful earnings that can be distributed to investors are the driving factors of any long-term investment. There are many ways that investors have tried to describe these aspects of a business that make for a successful investment, but I prefer to define it as the quality of a business. Therefore, Hershey must have a high-quality business in order to be considered among the best businesses in the world and a worthy comparative tool.
Defining a high-quality business that can continue to provide a high return for investors for decades can appear to be a daunting task, but fortunately, we can look to Chuck Akre for advice on how he finds these rare gems. Akre describes these high-quality companies as compounders based on their ability to continually grow over long periods and has developed an investment methodology based on the analogy of a three-legged milking stool. Akre believes that the best businesses are those that can compound their owners' capital at an above-average rate; generate a high and sustainable return on invested capital; possess a real competitive advantage in their industry; and are leaders in a market that enjoys strong, long-term growth. These businesses typically operate in a durable and resilient marketplace/sector and have demonstrated their ability to compound capital at high rates of return for decades. Akre breaks down these characteristics into three legs of a stool that prop up this investment thesis and represent the three key criteria he looks for in an investment:
Extraordinary business: The business must have a sustainable competitive advantage that allows it to earn above-average returns on capital.
Talented management: The company must be managed by a talented and experienced team with a long-term investment horizon and aligned incentives.
Great reinvestment opportunities: The company must have the ability to reinvest its earnings at high rates of return with a long runway for future growth.
Akre believes that by focusing on these three criteria, investors can significantly improve their chances of finding successful investments.
The First Leg: Extraordinary Business
Among the pantheon of iconic American brands, Hershey stands out as a true leader, embodying the very essence of an extraordinary business. With a rich history spanning over a century, Hershey has consistently delighted consumers with its delectable chocolate, sugary, and now savory creations.
This commitment to quality has continued since its founding as Milton Hershey dedicated himself to crafting exceptional products that would bring joy to people's lives. This commitment to excellence remains the cornerstone of the company's philosophy to this day, guiding its every decision and ensuring that its products consistently exceed consumers' expectations. Over its 100+ year history, Hershey has developed and acquired iconic brands in the chocolate, sweets, and snacks space including Hershey’s, Reese’s, Kisses, Jolly Rancher, Brookside, Kitkat, Twizzlers, Ice Breakers, Skinny Pop, Pirates Booty, and Dot’s Homestyle Pretzels.
The Hershey Company - Brands
These timeless brands have maintained mindshare and wallet share with consumers and continue to be the foundation of Hershey’s competitive advantage as the company utilizes its strong brand equity, product innovation, and consistently superior quality to demonstrate its pricing power. To use common investing parlance, these brands provide Hershey’s primary “moat” for its business as it wards off competitors from its highly attractive business “castle” and continues to grow its earnings power.
While saying that a company has a moat and can defend its business is easy, the real quality of a business is demonstrated when a company needs to utilize this moat to defend itself. That is exactly what Hershey has done over the last several years as the company has been attacked by widespread inflation, fierce competition from name brands and private label competitors, and, more recently, targeted weight loss treatments.
Starting with Hershey’s pricing power, their place in the confectionary business has been proven to be a highly attractive model that is most easily exemplified by one of Berkshire Hathaway’s greatest investments in See’s Candies. In 1972, Charlie Munger convinced Warren Buffett to invest in a business with a long history of brand loyalty and strong customer relationships, which gave it a significant competitive advantage over its rivals. They came to understand that this strong branding provided the business with a durable competitive advantage that gave it pricing power and the ability to charge higher prices for its products allowing See’s Candies to continually generate substantial profits. As a result of its strong business model within the confectionary market, See’s Candies has generated outstanding returns on capital over the long term with very little capital investment requirements providing Berkshire with the ability to reinvest the earnings generated by See’s Candies to further compound growth across the parent company’s vast number of privately owned businesses and public investments.
While Hershey operates in the same very attractive confectionary space, See’s Candies’ direct-to-consumer business model is slightly different from Hershey which operates under a separate wholesaling business model. For the vast majority of their business, the company must first work with distributors who supply Hershey’s products to retailers, like Walmart, Kroger, and Costco, that get Hershey’s products on consumer-facing shelves. Hershey has developed deep relationships and partnerships with these retailers to gain shelf space in an extremely competitive environment and ensure that consumers have access to their favorite offerings. At the same time, Hershey has demonstrated their ability to maintain and grow their market share in this wholesaling market while increasing prices in line with or above inflation. Between 2019 and 2022 this has resulted in a net sales growth of 7% on average with approximately 4% coming from price realizations and 3% coming from volume growth. Diving deeper into this period, Hershey shared on their 2023 Investor Day that they have been able to drive up to 10% net sales growth during the inflationary period of 2021 to 2023. This revenue growth from a mix of price and volume increases is aligned with the company’s long-term algorithm of 2 - 4% net sales growth.
Investor Day 2023, The Hershey Company
Hershey has driven even further growth in its earnings and cash flows through operational efficiencies and optimized costs across the business. Hershey has seen a compound annual growth in earnings per share and operating cashflow of 12.3% and 13.3% respectively between 2017 and 2022. When compared to its S&P Food peers, Hershey’s earnings per share growth is more than 4 times greater. Hershey predicts this outsized growth will continue into the future with earnings per share growth of 7% to 8% in 2024 and 2025 with 6% to 8% growth after 2026.
The Hershey Company 2022 Annual Meeting of Stockholders, May 2023
However, despite Hershey’s success in the past, this wholesaling model also presents a potential point of weakness for Hershey as the retailers that Hershey’s partners with operate under razor-thin margins and are continually looking for opportunities to increase their profits and share of consumer dollars. As a result, many retailers have expanded their private label offerings in an attempt to take share from name brands by charging cheaper prices for similar products. This has been an especially attractive opportunity for retailers in an environment where inflation puts additional pressure on the branding power of companies as consumers are forced to continually calculate the value of the items in their shopping carts. Based on the most recent comments from various consumer staple companies, it seems that the competitive environment is expected to further intensify, particularly as costs come down and local brands and private labels become more aggressive.
“Private brand share is another thing. You're seeing that number come up. We have more influence over what's happening with private brands than we do with branded product. And we do need some of these branded suppliers that are in dry grocery and consumables to get top-line focused more than they have been for a while.”
Walmart Q1 2024 Earnings Call
“On the discretionary portfolio, we continue to build our assortment strategy for the long term. We fully believe in our multi-category portfolio, that it offers us an ability to meet the guests' needs in a variety of different times. At the moment, given where the consumer is spending, we're, of course, leading on the strength of our Food & Beverage portfolio”
Target Q2 2024 Earnings Call
Hershey of course, is not immune to this challenge as retailers have found opportunities to capitalize on private label demand, especially in salty snacks. However, the company has taken steps to solidify its strength and positioning in its candy, mints, and gum segments where it can capitalize on a more friendly environment. Hershey’s primary market positioning in the confectionary space has seen resilience against private label opposition with a market-leading private label penetration of 3%.
“So as we look at our business, certainly, we're seeing a lot of strength in Pretzels in the category as well as our Dot's distribution opportunities. And as we look at ready-to-eat Popcorn, certainly, we do know that consumers are focused a little bit more on satiety. And we've had some retailers focus on private label and merchandising in particular.
Yes. So l'd start by saying that we have seen some some softening in Salty Snacks overall.”
Hershey Q3 2023 Earnings Call
“So certainly, there is a bit more private label in Salty than in CMG. But we have considered -- we've continued to see that, while private label has ticked up a bit, our brands have continued to remain quite strong and do incredibly well. And as we look at private label, even within the confection category, while there has been increased activity there, it's remained a very small part of the category, less than 3%.
And what we're seeing overall, I'd say, is pretty consistent with what we've seen historically. We have seen some higher levels of innovation as supply chains have gotten stronger and people have been able to support innovation. We have seen some increases in private label, I think, with the economic environment in both Confection and in Salty. But frankly, the results of those entries have been somewhat mixed. And certainly, our brands have held up really well.”
Hershey Q2 2023 Earnings Call
Over the last several years, Hershey has very clearly articulated their competitive advantage against direct competitors and rising pressures from private label offerings through their strong brands and their resistant industry positioning.
It is important to also address recent competition from Mr. Beast’s Feastables candy bars. I certainly can appreciate the power of the creator economy, and Jimmy Donaldson as Mr. Beast is the unchallenged king of this market with an audience of almost 400,000,000 subscribers across all of Mr. Beasts’s channels. However, I believe that Donaldson’s pursuit of building a portfolio of products is a result of Mr. Beast’s unparalleled growth and advertising power in an underappreciated online platform more than his belief in creating sustainable leading businesses. Donaldson has elaborated on his reasoning behind creating brands including Feastables during interviews including his conversation with fellow YouTube creators Colin and Samir. Donaldson has found extreme difficulty in partnering with organizations that will provide him a greater return than he would be able to achieve by investing in and subsequently advertising his own products during his videos. Furthermore, there have been several examples demonstrating Donaldson’s commitment and focus on giving away his money rather than building and growing businesses. Many of the points made in the popularized Bear Cave Newsletter post, Problems at Hershey, are valid, but despite advertising directly to a passionate and dedicated group of fans with videos that routinely get several hundred million views, the threat of Feastables taking a large portion of Hershey’s market share is extremely overblown. As a result, I feel that despite never before competing against a viral brand owner like Mr. Beast in its 100-year history Hershey will prove to maintain its branding power and continue to hold a leading share with consumers.
At this point, it is likely too early to see how Hershey will defend its business against its next challenge in the form of targetted weight loss treatments including Novo Nordisks’ Wegovy and Ozempic. However, its current expansion into healthier snacking and confectionary options appears to be positioning Hershey well for the future. Hershey has continually demonstrated its ability to defend itself from competitors with its wonderful branding and operational moat, solidifying its position as an extraordinary business that is up to this next challenge.
The Second Leg: Talented Management
Although Akre’s second leg may be one of the hardest to define, it is one of the most important. Akre believes that compounders must be run by talented management who are aligned with shareholders. This can be most easily identified by finding companies with experienced leaders that have a track record of success, a significant history of intelligent capital allocation decisions, and are shareholder-oriented typically with significant ownership in the company. Ultimately, talented management is required to guide companies through a wide variety of challenges that are faced in competitive market environments while ensuring efficient use of capital for the benefit of shareholders.
First and foremost, Hershey presents one of the greatest examples of alignment with shareholders through its largest and most important shareholder with approximately 80% of the voting power and over 25% of the shares outstanding in the company, the Hershey Trust Company. The Hershey Trust Company was created to fund the education of disadvantaged children and contribute to philanthropic goals centered around health and human services in 1905. Aligned with Milton and Catherine Hershey’s vision, the trust is dedicated to maintaining a positive impact on the students of the Milton Hershey School and the Hershey, Pennsylvania community. This central goal of providing for the community has served as an altruistic compass point directing the trust’s ownership in Hershey toward providing a sustainable and growing funding pool in the form of Hershey's stock.
Furthermore, Hershey’s management team is comprised of experienced leaders with diverse backgrounds and expertise. They possess a deep understanding of the confectionery industry and a proven track record of driving growth and innovation. Hershey’s team has fully demonstrated their ability to lead the company into the future.
Michele Buck is the Chairman of the Board, President, and CEO of Hershey with over 25 years of experience in the consumer packaged goods industry and is a proven leader with a track record of success.
Hector De La Barreda, the Senior Vice President, Chief Global Business Platforms and Process Optimization Officer, has a deep understanding of Hershey's international markets and a proven track record of leading successful transformations.
John Rupp, the President of North America Confectionery, has a wealth of experience in the confectionery industry and is passionate about growing Hershey's business in the U.S.
Mary Beth West, the President of North America Salty Snacks, is a results-oriented leader with a strong track record of success in the food industry.
Michele Raup, the President of International, has a deep understanding of Hershey's global markets and a proven track record of leading successful turnarounds.
In a continually ESG-focused environment, Hershey’s management has been pushed to further analyze their business practices. This was put into even deeper focus in a 2023 Last Week Tonight episode that highlighted some of the negative aspects of the cocoa industry, including the common use of child and underpaid labor in West African farming countries, irresponsible business practices by cocoa market makers, substantial climate impact through unsustainable farming practices, and greenwashing by corporate confectionary companies that are promoting unsubstantial progress.
In contrast to this exposé, Hershey's management has demonstrated commitment to upholding high standards of quality and ethical practices in all its operations. Hershey’s management team is committed to fostering a culture of inclusivity, diversity, and ethical conduct, recognizing that these values are essential for long-term success. They place a strong emphasis on ensuring the well-being and safety of their employees and consumers, taking necessary steps to prevent and remediate instances of child labor in their supply chain. They are also dedicated to minimizing their environmental impact and promoting sustainable practices throughout their business.
Hershey's management is committed to transparency and stakeholder engagement. The company publishes annual ESG reports detailing its progress and performance against its sustainability goals. They also maintain open communication channels with stockholders, encouraging dialogue and feedback on ESG-related matters. Additionally, Hershey has established various committees and boards to oversee and guide its sustainability efforts, ensuring accountability and alignment with stakeholder expectations.
Investor Day 2023, The Hershey Company
Hershey's management has demonstrated a commitment to continuous improvement and setting ambitious goals for the future. They have established clear ESG priorities and are actively working towards achieving them. The company's focus on sustainability, social responsibility, and stakeholder engagement positions it well to navigate the evolving landscape and maintain its leadership position in the confectionery industry.
The company takes a proactive approach to addressing social and environmental concerns, implementing various initiatives and programs aimed at improving the quality of life for cocoa farmers and their communities. These initiatives include farmer training, providing access to financial services, and investing in infrastructure and education. Hershey also collaborates with suppliers, governments, and non-profit organizations to drive positive change across the cocoa industry.
Hershey's Cocoa For Good program is a 12-year, $500 million initiative that aims to create a more sustainable and resilient cocoa supply chain. The program focuses on three key areas:
Eliminating child labor: Hershey has committed to eradicating child labor from its cocoa supply chain by 2025. The company works with governments, non-governmental organizations, and other stakeholders to provide training and education to cocoa farmers, improve access to healthcare and other services, and support community development initiatives.
Improving farmer livelihoods: Hershey partners with farmers to improve their productivity and incomes. The company provides training on sustainable farming practices, access to financial services, and infrastructure development.
Creating a healthier ecosystem: Hershey supports programs that protect the environment and promote biodiversity in cocoa-growing communities. The company also invests in reforestation and other conservation efforts.
In addition to its Cocoa For Good program, Hershey also makes several other commitments to social and environmental responsibility. For example, the company has pledged to:
Reduce its greenhouse gas emissions by 50% by 2030.
Source all of its cocoa sustainably by 2025.
Use 100% renewable energy in its operations by 2030.
Make all of its packaging recyclable or compostable by 2025.
Hershey's social and environmental initiatives are an important part of its overall business strategy. The company believes that a sustainable and responsible supply chain is essential for long-term success. Hershey's commitment to these initiatives also reflects its values and its desire to make a positive impact on the world.
The Third Leg: Great Reinvestment Opportunities
Over long periods of time, a company’s returns will be approximately equivalent to its return on capital. Therefore, Akre points to businesses that can continually achieve a high return on their invested capital as proven examples of extremely effective vehicles that are able to compound owners’ capital over time. In order for a business to maintain these high returns on capital, it must demonstrate its ability to effectively invest excess cash generated by the business to earn above-average returns. Powered by an outstanding reinvestment engine, even an ordinary business can become a remarkable compounding machine. Unfortunately, there is no secret formula for obtaining high returns on capital over extremely long periods. However, business returns are often highly correlated to the qualitative aspects of the business, its industry, and the capital allocation decisions that management makes over time.
Hershey has consistently demonstrated a disciplined approach to reinvestment, with a focus on growing its core confectionery business while expanding into adjacent and similarly attractive markets. In the past, Hershey pursued growth in the adjacent markets consisting of mints and gum segments with acquisitions of brands including Ice Breakers, Breath Savers, and Bubble Yum.
More recently, Hershey has focussed its efforts on expansion into the health and wellness and savory snacks market. In 2017, the company acquired Amplify, which owned the SkinnyPop brand. In 2018, Hershey acquired the Pirate’s Booty brand from B&G Foods. And in 2021, Hershey acquired Dot’s Pretzels and its co-manufacturer Pretzels Inc. as well as Lily’s Sweets, LLC, a privately held company that sells a line of sugar-free and low-sugar confectionery foods. The acquisitions into savory snacks and health-conscious offerings have allowed the company to take the cash generated from the higher-margin chocolate category and reinvest into higher growth areas. From 2017 to 2020, the salty snacks segment grew sales by over 6% annually as compared to the chocolate segment which grew by over 3%. This growth is driven by an increase in the frequency of snacking occasions particularly at home with savory snacks representing almost 25% of the total snacking market.
Investor Day 2023, The Hershey Company
Hershey’s salty snacks business is growing rapidly and is expected to account for 11% of the company’s net sales in 2023. Hershey has honed their expansion specifically on ready-to-eat popcorn and pretzels offerings which demonstrate attractive growth areas within the salty snacks segment. Going forward, Hershey plans to continue to leverage its existing resources, expertise, and distribution network to grow its salty snacks business through the expansion of its acquired brands. Through this expansion, Hershey has maintained industry-leading margins and return on investment.
Investor Day 2023, The Hershey Company
These acquisitions have demonstrated Hershey’s ability to intelligently acquire attractive brands in growing segments that have valuable synergies with its existing business. These decisions have proven to be highly value-accretive for shareholders, but Hershey has remained disciplined in its capital allocation policy with a balanced focus on intelligent growth and capital returns to shareholders.
Investor Day 2023, The Hershey Company
The company has used its excess cashflows to support growth and create value for shareholders by prioritizing reinvestment opportunities, sustainable dividends, opportunistic share buybacks, and debt reduction. This strategy has contributed to substantial growth as Hershey's reinvestment rate has averaged between 35% and 55% over the past four years. The company has a strong track record of returning cash to shareholders through dividends and share repurchases.
Outside of expansions in the United States food segments, Hershey has attempted to grow globally. However, Hershey's international expansion has been a mixed bag. The company has made some progress, but it has also faced some challenges, and it remains to be seen whether Hershey will be able to achieve its long-term growth goals in international markets. Hershey is still working to prove that its strong distribution network and global presence will yield substantial returns by further expanding its brands and offerings outside of the US despite already selling its products in over 90 countries around the world.
The Wrap:
Hershey's distinguished track record of success that has been obtained through its strong competitive advantages, highly competent and investor-focused management, and intelligent capital allocation makes it an exemplary case study for investors. Hershey has effectively compounded capital for decades and proven that it will continue this growth into the future supported by its three strong stool legs:
Hershey’s exceptional business quality, iconic brands, enduring competitive advantages, and commitment to quality positions it among the world's leading businesses.
Hershey's talented management team with a proven record of driving sustainable growth and guided by its’ mission-driven leading investor, the Hershey Trust Company, further solidifies investor’s confidence in a bright future ahead.
Hershey's disciplined approach to capital allocation and focus on strategic reinvestment opportunities into adjacent markets, such as health and wellness and savory snacks, have complemented its core confectionery business and contributed to its consistent growth.
Investors seeking a benchmark for evaluating investment opportunities can confidently use Hershey as a comparative tool, underscoring its significance as a compounding machine that offers exceptional long-term growth potential. Continually studying companies like Hershey will help investors better understand the qualitative aspects of great businesses and determine how they have built their competitive advantages and moats. However, one question remains when attempting to identify a great investing opportunity:
“How can investors effectively compare similarly attractive quality compounders to existing opportunities like Hershey?”
The answer can be found by examining the companies’ financials and will be discussed in Part 2 of this article which will be released after Hershey’s 2023 Full Year earnings results are released on February 8th, 2024.
The information in this post is not intended to be, nor does it constitute, investment advice or recommendations. In no event shall Quartest or its author be liable to any member, guest, or third party for any damages of any kind arising out of the use of any content or other material published or available through this Substack, or relating to the use of any content. The information on this site is not guaranteed for completeness, accuracy, or in any other way.
Citations and Resource Center:
The following resources were utilized in the process of writing this post:
Trying to Solve the Investment Puzzle | Chuck Akre | Talks at Google
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