The Road to Recovery: Hershey Foods Seeks Redemption After Recent Downgrade

Investors in Hershey Foods (HSY) have been nursing their wounds following a recent downgrade from “Buy” to “Neutral” by BofA Securities. This setback is part of a growing trend, with four different brokerages downgrading their ratings on HSY in just the past two months, despite the company’s impressive Q3 earnings and sales performance. However, despite these challenges, there are several positive indicators that suggest Hershey may be on the brink of a turnaround.

Hitting a Rough Patch

The latter half of this year has not been favorable for HSY. After reaching all-time highs in May, immediately following a strong Q1 report, the company’s shares have been on a consistent downward trajectory. In fact, they have plummeted by over 30% in the past six months. Nevertheless, the recent consolidation of the stock price might be an early sign that HSY is poised to recover.

Positive Signs Amid Challenges

While HSY faces headwinds such as the rising popularity of weight-loss drugs (GLP-1s) and persistent cost inflation, there are several encouraging trends that could facilitate a more substantial recovery.

1. Expanding Adjusted Gross Margins: HSY has seen steady expansion in its adjusted gross margins throughout the year. The company has implemented multiple price hikes and believes it has positioned itself well across its product categories. To combat cost inflation, HSY is banking on upcoming capacity expansion, which should help maintain its margins. Management has also noted healthy demand, particularly in its Sweet segment, and increased capacity should improve productivity.
2. Steady Volumes: Despite consistent price increases, HSY has managed to maintain its volume levels. While volume growth has fluctuated throughout FY23, it has never fallen by more than low single digits. HSY boasts a portfolio of well-established brands that consumers are unlikely to trade down from. While private labels have seen a minor uptick, they still constitute a small portion of HSY’s business. The dominance of brands like Reese’s and Hershey Kiss makes it improbable for generic brands to significantly erode HSY’s sales.
3. Resilience to GLP-1s: HSY remains largely unaffected by the rise of GLP-1s and does not foresee a significant immediate impact on its business. Although the long-term effects of weight-loss treatments are uncertain, HSY, like other snack food giants such as PepsiCo (PEP) and Conagra (CAG), is not overly concerned. Should adoption rates of weight-loss drugs surge, HSY can take strategic measures to counter potential damage, including expanding its range of smaller snack sizes and exploring opportunistic mergers and acquisitions.

Strengths and Opportunities

Despite its recent decline, HSY stands out in the consumer packaged goods sector. It boasts a remarkable market share, estimated to be nearly 50% of the U.S. chocolate market. Additionally, the company has a robust portfolio of products that are challenging for competitors to replicate. These strengths may provide a buffer against further declines.

Looking Ahead

While HSY may continue to face downward pressure through 2023 as investors harvest tax losses, there is reason to believe that the company is nearing a bottom, with substantial upside potential in the coming year. The combination of positive indicators, including expanding margins, stable volumes, and resilience to emerging threats, suggests that Hershey Foods is on the path to recovery.

Bottom-line: Hershey Foods (HSY) may have weathered recent downgrades and market challenges, but it is not out of the game. With a strategic approach and its strong market position, HSY is poised to rebound and potentially deliver attractive returns for investors in the near future.