TIVP012: Hershey (HSY): A Deliciously Beaten Down Stock? w/ Shawn O'Malley & Daniel Mahncke

26:19And then the origins of the famous Hershey Park stem from him trying to improve employee morale by providing them with some leisure activities for workers and family. And then in 1907, Hershey produced the company's famous Hershey Kisses chocolates for the first time. And to jump a bit ahead in the story, Hershey would round out the other pillar of its business in 1963 by merging with Harry Burnett Reese's Company, who had invented the Reese's Peanut Butter Cup. And then today, Reese's represents about 30 % of the company's sale. So obviously, that merger has had a lasting impact on what Hershey's is today.

26:56The other aspect of its candy empire is KitKat, which you might be interested to know isn't entirely owned by Hershey. For context, in 1969, Hershey received a license from a UK-based company known as Roantree to manufacture and market KitKat and Rolo in the US. And after Hershey's competitor Nestle acquired Roantree in 1988, it was still required to honor that agreement. And because of that, it continues to make and market KitKat products in the US only, but that license would revert back to Nestle if Hershey were ever sold. So losing the licensing rights to the KitKat brand has actually been a major sinking point in the sales offers that Hershey has received.

27:37Because of course, when a company like Mondelez comes and offers to purchase Hershey, they're not accounting for KitKat in that offer. And then from Hershey's perspective, because they're going to lose KitKat operations in the US, they don't see the offer as being high enough and being valid. So again, that is part of the reason why I don't think Hershey would ever sell. And it's not entirely because of the trust company, but certainly the trust company is something worth understanding better. So there it was, huh? The KitKat story I was waiting for. And it's kind of funny how every time you do not know what product in the food space or what company sells a product in the food space, it seems to be Nestle.

28:16I thought it was interesting when you talked about the Hershey Trust and the 80 % voting power they have. I do not have a strong or I do not have a generally strong opinion on having one large shareholder. I think there are positives and negatives. And I think Hershey does a great job of showing both. So a positive, in my opinion, would be that you have a long term focus instead of falling for these hectics of Wall Street and this short sightedness of focusing quarter to quarter and that kind of being your worldview, right? And then you have the negatives. As you mentioned, as a shareholder, you have very little influence on what happens to the company.

28:55And if you have a stubborn owner like the Hershey Trust seems to be looking at all those offers they declined, it can be a bit frustrating. For example, the market seemed to like the idea of a merger. I think the stock went up about 10 % on the news. But now that that seems to be off the table, what does Hershey's roadmap for the future look like? I mean, what's something that shareholders and maybe you can get excited about? Let's take a quick break and hear from today's sponsors. Even Einstein had blind spots. That's why modern science is built on the idea of peer review. Investing may be more art than science, but that doesn't make peer feedback any less valuable.

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32:07And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. All right, back to the show. With a company as old and mature as Hershey's, I'm not expecting anything too dramatic, but they do continue to acquire new brands here and there that sort of round out their business. Last November, for example, they acquired Sour Strips, and they've also aimed to increase their production of gummy candies by 50%, which they've paired with a partnership with Shaq. They literally call them Shaqlicious XL gummies, and they're just really big gummies of Shaq's face. But it's one example of how they can use these sorts of promotional partnerships to drive new product lines like gummies, which wasn't previously a big area of business for Hershey.

33:00And at the same time, despite having so much brand power, Hershey's has been under some competitive pressure. We mentioned already that consumers have shown a good deal of price sensitivity around confectionery treats and And folks trading down to lower-priced candy brands and store brands is a real pain point for them coming out of the pandemic. And they also face challenges from up-and-coming brands too, like Mr. Beast's chocolate bars. For listeners in the audience who don't know Mr. Beast, he's basically the most popular YouTuber in the world and an icon for Gen Z in many ways. And his brand is so big that I'm not sure Hershey's could ever hope to compete with it with paid marketing.

33:41You know, chocolate is not his top focus, but his brand is growing really quickly and is continuing to be rolled out across the US. And that will only eat away at Hershey's sales on the margin. So I do find that concerning. I'll also mention that North America remains Hershey's primary focus because it's so hard to scale confectionery products internationally, right? Hershey's is sold in 60 countries, but most of those sales outside of North America are rounding errors to the broader business. The reality is that people tend to have strong regional biases toward their favorite candies, something I know you know, Daniel.

34:20And so recreating Hershey's success in the US within a different cultural context with existing or new chocolate brands is just no simple thing to do. Seize Candy has been one of Warren Buffett's best investments, teaching him enough about brand power and pricing power to eventually invest in Coca-Cola, which we both know has been one of his biggest winners ever. And even See's Candy couldn't overcome the regionalism of the confectionery industry. It's particularly popular in California and the Western US, but otherwise, it's not that widely known, despite all the publicity that Buffett has given it over the years.

34:56There's a lot of nostalgia surrounding the brand and its core markets, but outside of there, these emotional attachments really don't translate. One thing that does offer some room for optimism though is Hershey's plan to better manage its operating costs, which is something it can directly control and can help offset these upward swings in cocoa prices that we've seen. One of the things they've done is that they've digitized their product portfolio with a new system called SASP S4 HANA system, just kind of a mouthful to say, but it's a core part of what Hershey's calls its AAA initiative, which stands for Advancing Agility and Automation.

35:35And basically, it's an enterprise resource planning software that gives them real-time insights into inventory needs. It allows Hershey's to have a live look at demand on the retail side and supplies of cocoa, sugar, and all the other ingredients that go into production. And because of that data, it's expected that they'll be significantly more accurate in forecasting supply and demand, allowing Hershey's to minimize waste. And obviously, all that's really valuable from a supply chain perspective and saving costs for Hershey's. And for example, you can imagine that with Reese's, they need to know how many they need to make.

36:10And they also need this system that can help tell them how many tons of peanuts and cocoa to go out and purchase. So the system enables managers to be more proactive about maintaining their production lines. It could help them figure out the best time to even repair and maintain or clean equipment and a lot of stuff like that. So it just adds a lot of efficiency in different ways. And management expects it to be fully complete by 2026, which is anticipated to save them about $300 million per year from there. So it's pretty substantial. Who knows if that comes to fruition? I wouldn't necessarily factor it directly into my analysis, but like I said, it gives me maybe some reason for optimism and shows that even after all these years, Hershey's is still finding ways to boost efficiency, which can unlock earnings growth.

36:56Trey Lockerbie, Ph.D.: You mentioned so many interesting facts now. One of the things that came to my mind is that it's interesting how we just said that the legacy brands in the industry have such a strong regional focus. Hershey is mostly being in the US, C. Scandie even part of the US, and then many brands that are in Europe and everything. And it still looks like those personal brands, these influencer brands, have far more reach. You know, Mr. Beast is obviously from America, but everyone here knows him too. And I think that's true for every country. I think he even does his videos now in pretty much every language you could imagine.

37:33And for some reason, it's that culture and region does not play a huge role there anymore. So I do consider this long term, not maybe in the next two or three years, but long term, I do consider that a risk for companies like Hershey, just because that's something they never were able to do. And it seems like influencers, also European or German ones, seem to be pretty successful in doing exactly that. But staying in the here and now. So how does the competition look like from the legacy brands? And how does Hershey fit into that field? Hershey's is at the top of the industry together with a few select companies, some of which are also privately owned, so not all publicly traded.

38:15And those are Mars and Ferrero. And then there are others such as Nestle, Meiji, and Mondelēz that are public companies. And together they form a small cluster making up the six largest confectionery companies globally with Hershey ranking fifth according to revenue. So it's not the biggest dog in the race there. And for me, the competition story really mostly surrounds Mars. They've been a really tough competitor for decades now. And fun fact, Mars is the reason that Hershey had to create a marketing department back in the 1960s to counter that competition. Mars makes M &Ms, Skittles, Twix, Pop-Tarts, Dove Chocolate, Snickers, Cheez-Its, Pringles, and also Rice Krispie Treats.

39:02So a lot of well-known brands there. And I mean, that is one heck of a lineup. But as of 2019, the Hershey company was still by far the leading US chocolate firm with control over 44 % of the US confectionery market. And Mars comes in second with roughly 30 % market share. Funny enough, though, Hershey actually helped build Mars. In 1923, Mars' founder turned to Hershey for help with getting the necessary chocolate supplies for its now famous Milky Way bar. and what was once a small regional brand quickly turned into this smashing success thanks to the Milky Way bar and suddenly Mars wasn't just a peer but now it was a close competitor and despite competing with each other Hershey's actually continued to supply Mars with chocolate well into the 1930s until Mars kind of upped the ante of the rivalry by vowing to overtake Hershey's as the king of chocolate, which are still working to do to this day.

40:05In response to the Milky Way, Hershey unveiled the Mr. Good Bar, which is basically just a Hershey bar with roasted peanuts. And then Mars responded with the creation of the Snickers. So there's some real innovation here, especially at that time in the world of chocolate candy. And really, in hindsight, I kind of see Mars as being way more effective at churning out popular new products. I've certainly had way more Milky Way bars than I've had Mr. Goodbars in my life. And one of the other really compelling products they created was M &Ms. And at a time, that was pretty innovative for the protective shell that those candies had.

40:41It made them more resistant to melting, which is the biggest problem for any chocolate candy-based treats. And more recently though, Hershey's has unveiled products like the Reese's Caramel Big Cup, and that actually ranked as the number one new candy innovation in 2023. So at least recently, Hershey's has been a bit more aggressive about launching new types of products. You mentioned that Mars does a pretty good job, both marketing-wise and also putting out new products. And if I think back, I must admit, I also know a lot more Mars products than I know Hershey ones. You just said it, and I was fascinated to hear, that the M &Ms are actually resistant to melting because of their protective shell.

41:19I never thought about that. I didn't think that innovation is actually something that we see in the candy space too. But I guess it says a lot more about my knowledge about the candy space than anything else. I thought it would just be about the taste. But getting back to the operational side, because there's something I think we should talk about. And that's that Hershey's CEO, Michelle Bach, actually announced that she will retire in June 2026. And the stock reacted with a 2-3 % decline. And I still remember when I looked at Nike, that Nike stock actually had a 10 % rally the week that Nike CEO John Donahoe was let go of, let's say like that.

41:59And I was seeing that the stock declined after the announcement of Michelle Buck retiring. It does seem like she was a popular figure in the company. Do you think it will be a problem looking for a successor that's as capable or who's as capable as she was? It's always a big deal when you're changing leadership at the top, right? And yeah, it was announced that Michelle Buck will be stepping down in 2026 after having led the company since 2017. So for all the headwinds and challenges facing Hershey that we've already discussed as if there weren't enough, now you layer in succession planning and these leadership changes.

42:40And again, it's just no surprise to me on why the market has mostly soured on the stock over the last two years. But at 63, it's also not unprecedented to want to retire. And fortunately, there is a long lead time ahead for them to kind of figure out a plan. There's apparently a special committee that is leading the search, and they're considering both internal and external candidates, I'd presume. While she has helped lead the diversification efforts into salty snacks, like Dots pretzels and Skinny Pop popcorn, Hershey's is still not as diversified as its peers. So there is a lot of room for improvement here.

43:18Nestle, for example, has products that range from dairy to coffee. And I think you said earlier, anytime you go to a store and you don't know what company has produced a product, there's a good chance it's Nestle. And even Mars, as we talked about, for all their innovation in candy, now they have pet food brands, which maybe is not a good or bad thing. But the point being, a lot of these companies have seen the writing on the wall and have significantly diversified. And Hershey's stands out for falling short of doing so completely. But I did find this quote in a Bloomberg article from a former higher up at Hershey who remained anonymous, talking about Michelle Buck.

43:56And he said basically that, quote, Michelle knows that business inside out and backwards. It's going to be hard to replace her. And so that makes a lot of sense then that the stock sold off 2.5 % immediately after it was reported she'd be leaving. And I'm sure it's contributed to the continued weakness in Hershey's stock over the following months since that report came out. And this comes after the executive that Hershey's handpicked to lead its US candy division also quit just three months into the job after having been with Pepsi for 23 years. And again, I think that's just showing how tough of a business Hershey is to run right now.

44:34You have a lot of these longtime industry veterans bailing on the confectionery market. And we haven't even talked about the new presidential administration and how RFK Jr., who's been tapped to be the country's top health official, has basically vowed to directly take on companies like Hershey for their responsibility in widespread health problems like diabetes and childhood obesity. So from lawsuits to regulations forcing them to change their formulas and supply chains to simply bad press, the risks from government and public scrutiny are also mounting here for Hershey to say nothing of tariffs either, which is a really big elephant in the room.

45:15Hershey's is in some ways, arguably as beloved as any brand like Disney or Apple, especially around the holiday season, but it just feels like the business cannot catch a break right now. And that is making the markets increasingly paranoid about its prospects, which if taken to an excess can actually create attractive buying opportunities. And some investors have certainly recognized that as the stock just in the past few weeks has mounted a bit of recovery after the Q4 earnings. I have to add to the management discussion that I usually do not pay too much attention to management if the company is as big as Hershey's.

45:51However, if someone leaves after just a couple of months, and he's known for usually staying decades at different companies, it does seem a bit odd to me. But now maybe kind of initiating a new topic. There's a quote of Buffett coming to my mind, as so often the case. I mean, part of my internal monologue is just Buffett quotes. No, obviously I'm kidding, but I still want to phrase it out and then ask you what you think about it. So the quote is, the single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business.

46:30And if you have to have a prayer session before raising the price by 10%, then you've got a terrible business. So you mentioned Apple and Disney, two companies with immense brand and pricing power. How would you say does Hershey fit into that picture? So as an investor, that is clearly a big question. And I can't know what will happen with cocoa prices. But if I had to guess, the outlook here has a good bit of fear and worst case scenarios already baked in, meaning the range of outcomes actually probably skews toward the market at at some point being relieved that cocoa supply doesn't remain as tight as feared for as long as currently feared.

47:11I guess another way to say that is we can probably look past the rise in cocoa prices, not because they won't continue to be high, but because at some point that will just be a part of their business structure and won't be negatively impacting profits relative to previous years. And I tend to think that if prices are high enough, though, we will always find new ways to produce something or unlock supplies that were previously unavailable. And I'm sure the same is true with cocoa. Maybe I'm naive, but without being an expert on cocoa supply chains, high enough prices should eventually induce more farmers to plant cocoa trees.

47:46But I'm kind of sidestepping the question because the bigger question here is, does Hershey's have pricing power? And if Hershey's doesn't have pricing power over its customers, then that's a much bigger issue for shareholders long-term. Because whether it's cocoa or sugar or tariffs or taxes, whatever it is, there are a lot of different angles that cost can be imposed on this company. And if Hershey's cannot adequately pass it on to consumers, that's a big problem for shareholders. Again, it's one thing for cocoa prices to rise, but if Hershey's prices rise correspondingly, then there shouldn't really be any impact on margins, at least in theory.

48:26The business would basically just be as profitable as before. And in that case, it wouldn't really matter if cocoa prices swing from year to year, but that's contingent on them being able to raise prices in line with the increases in input costs. And in other words, I guess you could say if Hershey could adjust prices as needed, they could keep their business intact, assuming there's no sensitivity from customers. In economics, though, you might say that demand for Hershey's products resembles what you might call elastic demand, meaning that customers are sensitive to pricing and will purchase fewer items if prices jump too much.

49:02You're not going to pay any price for a chocolate bar. There are limits to what consumers will expect. Whereas in gasoline is the classic example of an inelastic good. Demand is not that sensitive to prices. And for anyone in the audience who doesn't believe me, consider the price you'd be willing to pay to fill up your car with gas if you ran out on the highway. People see cars as an essential part of their life and correspondingly gas is too. So if you ran out of gas on a road trip and the only gas station nearby was$30 a gallon, I would still pay it at least for one gallon because what other option is there until you can find another gas station?

49:42And so to bring it back to Hershey, we know that structurally people aren't going to be as insensitive to chocolate prices as they are with gas. It's just the reality. But we also know that people really love chocolate. So they might be willing to absorb some amount of higher prices and maybe more than you'd think. I know I've definitely splurged on some chocolate bars that might've cost me five or$6 for a few ounces of chocolate. But when you're craving chocolate, that price maybe doesn't seem that steep in the moment. I've certainly regretted it after, but when I'm chowing down on a Hershey bar and kind of enjoying that moment of bliss, $5 doesn't seem that crazy.

50:17And then this gets into a whole nother conversation about how Hershey's is priced relative to its competition. And that's what I think really is at the core of its pricing power discussion. If every chocolate product in the world raised prices exactly in line with increases in their cost for cocoa and did so at the same time, Hershey's would probably see no drop-off in sales volumes. But obviously, that is not what happens. Every chocolate brand does their own assessment of how their economics work out. They hedge their costs differently, and they decide then how much of an increase in input costs they can absorb versus how much they can and want to pass on to consumers.

50:56So Hershey's is not raising prices in a vacuum. That's my biggest takeaway. If they raise prices by 10 % while private label brands only raise prices by 5%, then Hershey's has become relatively more expensive compared to the other options. And when we ask whether Hershey's has pricing power, this is really what we're talking about. If Hershey's has a degree of efficiency or hedging expertise that can help them hold off on price hikes for longer than other brands, that's one thing. and sort of a separate discussion. But can Hershey's raise prices in excess of discount brands? Or if they become relatively more expensive, is brand loyalty strong enough to prevent people from trading down to cheaper confectionery alternatives?

51:41Hershey has seen some minor declines in volume during periods of aggressive price hikes like late 2022, but these have been offset by revenue growth due to that higher pricing. And Hershey has generally maintained an average price premium of about 5 % to 10 % for its core products over competitors in North America, reflecting that it is something of a premium product, you might say, and one that goes from being discretionary for most of the year, but arguably becomes non-discretionary around Halloween and Christmas. Products like Kit Kat and Reese's are staple parts of what people expect to consume or pass out on Halloween, which is why I say their branding power magnifies to an extent during these times that makes them almost an essential good to some customers rather than just purely being an impulse purchase in checkout lines, which is kind of what they are for most of the rest of the year.

52:32And maybe you say the same about Valentine's Day. And on top of that, they've also historically engaged in what's known as shrinkflation, where Hershey reduces product sizes, such as reducing the size of Reese's peanut butter cups or the number of kisses sold in a bag. And that's sort of an alternative way to implicitly raise prices. There's a lot of nuance here at the product level, of course, and each product almost has its own pricing power and positioning in a way, right? Some products you can raise prices for more easily than others. For example, Snickers is often priced slightly less than Hershey's bars, but Hershey's has the ability to upsell through premium seasonal offerings like holiday-themed chocolate bars with peppermint.

53:12And that gives them these kind of temporary, but also recurring annual boosts to the company's market share and profit margins. And then in response to a wave of public health concerns about sugar that we've kind of alluded to already, Hershey's did lean into sugar-free chocolates with a brand called Lily's, which has its own unique perceptions amongst customers, but typically is priced at a 15 % to 20 % premium relative to regular Hershey's chocolate. it. So I think I'm kind of sidestepping the question on pricing power. In short, Hershey definitely has some pricing power given how famous their brands are.

53:49And that fame comes with some nostalgia and many, many years of marketing eating away at people's subconscious perceptions. And that all combines together to make it likelier that Hershey can raise prices without a proportionate decline in sales volumes. From a 30 ,000 foot view, I think this is something that they mostly could do either with price increases or shrinkflation going forward. And when equity research analysts bashed the stock for absorbing higher costs over the last year, at least, this has really only translated to a 1 % to 2 % decline in operating profits. So we're not talking about being completely unable to raise prices and massively damaged by higher commodity prices.

54:30Robert Leonard I think you've given a pretty good picture now on brand power and also pricing power. And I do know that you like to look at what Buffett does. And you already mentioned it today that he bought Sea's Candy, right? And that's kind of his investment or the investment that made him go more into the direction of buying better brands and buying those brands that have pricing power. Now, probably, and you also mentioned that one, Coca-Cola is the investment that most people would connect to Buffett in that way. Maybe even after 2016, Apple, that might be. But I know that you probably also picked Hershey because you see those parallels to CS Candy and what it did for Buffett.

55:12So once again, maybe how do you think Hershey fits into this? And just hypothetically, would Buffett and Munger currently buy Hershey, or at least like it for the business it is? Let's take a quick break and hear from today's sponsors.

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56:26I'll be waiting for you back here. Just like everybody else, there was a time when I was a beginner investor. And I have to say, investing is particularly filled with jargon that can just make it so difficult for new investors to understand what is going on. But it's never too late to get smarter about stock investing from the ground up. At The Investor's Podcast Network, we've made a habit of studying the world's best investors. And now I'm distilling those learnings into a simple course for you or for anyone in your life who you might want to share the gift of knowledge with. With my How to Get Started with Stocks course, you can master the principles of excellent lifelong investing with valuable insights for both beginners and pros.

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58:20Between the screener and Legend Investment Portfolios to reference, I've gotten a ton of ideas from TIP Finance. What are you waiting for? Take the next step in your investment journey today with the right tools at your fingertips. Grab your device and type into your browser, theinvestorspodcast.com slash tip-finance to get started. That's theinvestorspodcast.com slash tip-finance. All right, back to the show. I appreciate you bringing up Buffett and Munger because I'm always looking for a chance to pull a thread just a little further to have an excuse to talk about Charlie Munger. And in Poor Charlie's Almanac, which is this wonderful compilation of Charlie's thoughts over the years, there's a transcript from a speech titled Practical Thought about Practical Thought.

59:12And he muses about this hypothetical scenario of creating a$2 trillion company from a$2 million investment over 150 years, and basically what you would have to do to accomplish that. And even though it's about Coca-Cola, I think the same applies to Hershey's. And what he was ultimately describing is a phenomenon called the Lollapalooza effect, which is a combination of multiple psychological factors that combine together to distort our decision-making. So with Coke, you have a unique name that makes the product stand out. There's caffeine, which is one of the most addictive substances in the world, as well as sugar, which you could say the same for, and a whole bunch of marketing to condition people to associate Coke with fun times or beautiful women, and then standardized global production such that no matter where you are, the experience is consistent when drinking a Coca-Cola.

1:00:06And when you're traveling across some foreign land and stop into a store for a drink, all of those factors will implicitly bias you to pick Coke over anything else. You recognize the brand, you've been conditioned to associate it with positive feelings, you crave what's in it, and importantly, you know what to expect, which removes a huge barrier to purchase. One of the hardest things about sales is convincing people why they should care about your product and not having to do that to the same extent is really the advantage of Coke. Like I said, if you're in some strange new place and you're thirsty and you just want to drink, you're going to go with what's familiar.

1:00:43At least I would, right? Personally, you've never heard of the local cola brands and you have no idea if they're any good or what they'll taste like, but you know exactly what Coke is going to give you. And the same is true for McDonald's and any other global brand. And that's why I think the brand power behind Hershey's assets are so powerful. In some ways, Charlie Munger could have just as easily been describing Hershey's in his talk, which I'd really encourage anyone to check out. Hershey's has sugar, caffeine, and also chocolate, which has its own unique addictive properties. And combined with its consistent taste and brand recognition, that all goes into the Lollapalooza effect, subconsciously driving you to impulsively grab a Reese's or a Hershey's bar.

1:01:22And I can't say why Buffett and Munger never invested in Hershey's over the years. To some extent, you just can't invest in everything. And I'm not sure maybe they see some flaw in the business that I don't see. But at least from a high level view, a lot of the wonderful things that have gone into building a brand as powerful as Coca-Cola, you could say the same for Hershey's. Trey Lockerbie You and I both know that both Charlie and Buffett, they're huge on opportunity cost. So it's very well possible that they just had better opportunities available whenever Hershey came up on their mind. Now let us get back because I think we covered quite a lot of qualitative facts.

1:02:03Now maybe let us get back to the financials for a moment. We already mentioned that the last quarter was actually pretty good, a lot more stable than people would have expected. Net sales increased 8.7 % year over year. Net income more than doubled and the profit margin was over 30%. So all of that is a lot better than I would have initially thought. Now, we also mentioned that it's currently trading at 17 times earnings, which is pretty reasonable and seems like a good valuation. But the question is, will they be able to keep this performance up and also the valuation it comes with? Or will earnings drop so significantly that the valuation you have to pay now is actually not that attractive?

1:02:43So what's your take on that? And maybe on the quarter in general? Trey Lockerbie, The stock did pop after earnings. So the market clearly liked what it heard. And by the time people listen to this episode, the stock may not be as cheap as when we first recorded it. I think it's always funny though, to listen to earnings calls because the analysts can have their heads so deep in the weeds. It's very frustrating. They're worried about whether cost of goods sold is going to come in 0.5 % higher next quarter or something like that. And it's just frustrating because they don't really ask a lot of the big picture qualitative questions that at least as a long-term investor, I'm kind of keen to better understand.

1:03:23So there it is. That's my rant on equity research analysts. But for all the feared weakness in Hershey's business, sales rose almost 9 % year over year. The Shackalicious gummies were a big hit and were one of the fastest growing sweets brands last quarter. And Jolly Ranchers were really strong thanks to their new Jolly Ranchers Ropes product, which I didn't even know about, but I'm kind of excited to try at some point. And whether it's from mint and gum sales to Hershey's Brookside brand that sells blueberries covered in dark chocolate, everything looked pretty solid from what I could tell. And I think there's some excitement because Michelle Buck teased that the company will be unveiling their biggest Reese's innovation ever while having their fingerprints all over the Super Bowl, which they did from ads about Reese's Lava Big Cup to partnerships with Barstool Sports and Jason and Travis Kelsey's podcast, which is one of the biggest in the world right now.

1:04:18Probably not a coincidence that Travis Kelsey is dating Taylor Swift. And then on the salty snack front, again, everything just looks really strong. Skinny Pop had better sales than expected and continued to gain market share in the ready-to-eat popcorn category. And they teased some new Dots pretzels flavors to expand the brand's market share, though Dots is already the second largest pretzel brand. So it's worth mentioning that Hershey's business doesn't entirely revolve around chocolate or even sweets. And despite all the concern about cocoa prices, other parts of the business continue to keep chugging along.

1:04:53It was interesting to me that when talking about cocoa prices being very volatile, Hershey's CEO focused on the fact that cocoa trading isn't a very liquid market as opposed to having issues with the underlying supply, right? I've heard that because cocoa has gotten so expensive, traders have to put down a lot more capital upfront to make bets on futures contracts. And that extra capital or extra collateral needed to reduce leverage has driven a lot of value out of the market. It was almost as she was implying that the issue with cocoa price volatility, at least more recently, isn't because of supply, but it's actually because of illiquidity in cocoa financial markets.

1:05:35Maybe I'm reading into it too much, but nevertheless, I found that really interesting. And she actually says explicitly that they don't believe current high prices are reflective of market fundamentals. So I think that factored into the big relief that markets have felt about Hershey after it reported earnings. Hershey's has apparently secured their cocoa needs for the year and have seen cocoa supplies in the Ivory Coast and Ghana both rise 30 % since last year. So that all suggests that the worst is behind us and that's, you know, markets love nothing more than hearing those kinds of statements.

1:06:11But because of the hedging dynamics we discussed earlier, they do feel the effects at a lag. So higher cocoa prices will really first show up in 2025 and are going to hurt earnings. Gross profits are supposed to decline by as much as seven percentage points. And that ripples down through the rest of the income statement to reduce earnings too, of course. And the gross margin pain there isn't just from high cocoa prices, but also from higher sugar prices, higher labor costs and tariffs. So improvements in the cocoa market aren't going to fix all of their problems with input costs. I did dig into some equity research reports to see what Wall Street thinks of the company.

1:06:50And Morningstar's David Swartz does have some pretty good coverage of Hershey, I thought. His fair value target is$210 per share after the company's latest earnings report. And I just want to read some of the comments that he has in it. He says, The lasting rise in cocoa prices has been an Achilles heel for confectionery manufacturers, including Hershey. But we surmise the firm is employing a vast arsenal to blunt the hit, such as removing costs and raising prices while supporting its leading brand mix. And we don't surmise Hershey is banking on falling costs. Rather, management exuded confidence in growing earnings in fiscal 2026, absent a retraction in cocoa prices.

1:07:32And then he adds in the report, quote, we think concerns around inflation, consumers hunger for health and wellness, and the macro backdrop have weighed on shares. However, we posit the firm is taking a prudent approach anchored in extracting costs to fuel investments behind consumer-valued innovation. Between Hershey's dominant position versus private labels and the resilience of the category, as confectionery remains an affordable indulgence, we forecast 3 % to 4 % sales growth. So no shortage of Wall Street jargon there. But the sentiment is, and I agree with it, that Hershey remains focused on building its brand long-term while controlling what it can control in the short term.

1:08:14And even though earnings will probably fall off this year, there's good reason to think the company can bounce back in 2026, thanks to more favorable cocoa prices and its initiatives to bring down operating costs. While the company is valued at about 17 times earnings based on last year's results, because of the expected fall off in profits in 2025, its valuation is actually more expensive going forward, looking out over the next year, and it comes up to around 19 times expected earnings. It's kind of similar with Ulta, for anyone who remembers that episode from a few weeks back, and it's a company in our intrinsic value portfolio where you have this really, really strong brand with a lot of advantages that has just had a weak year.

1:08:55And the stock has been punished because of that, but much of those are short-term pains that don't necessarily indicate structural problems for long-term shareholders, at least in Ulta's case. One of the other bear cases, though, that I found interesting about Hershey is that 31 % of its employees operate under collective bargaining agreements. So in other words, they're basically unionized, and that can create real risks of employee cost inflation too. On the other hand, that creates more incentive for them to automate as many roles as possible to cut costs. And we've already seen some progress there, where I think a few thousand jobs have been trimmed because Hershey has found ways to automate them, which at a human level is not a great thing, but from an investor's perspective, it is a good thing.

1:09:37And given the strength of Hersey's brands and their wide brand recognition, especially in the US, and 36 % market share over the chocolate aisle in North America, which has only been growing since 2015, it doesn't surprise me at all that Morningstar classifies the company as a wide moat business. And I'd probably have to agree with them. One implicit way that this brand power sort of manifests is the reality that retailers would rather stick with stocking leading brands that are able to drive traffic into their stores rather than devote their precious shelf space to unproven suppliers who may not have the supply chains to provide inventory to their stores nationwide.

1:10:16And the amount of earned media and sponsorships that would be needed to recreate the brand power of Hershey's or Reese's is just massive. And that's why honestly, only Mr. Beast's chocolate products scare me here because he's the only one with a following large enough to build a brand that might even remotely rival Hershey. And other analysts have been less optimistic about Hershey, which is worth mentioning. Michael Lavery from Piper Sandler has been cutting his price targets for Hershey to$123 per share, but that is what makes the market, as they say. Everybody has differing views. Just looking at the analysts and their estimates shows how hard it will be for you in a couple of minutes to value Hershey.

1:10:56And it kind of reminds me, although they are not similar on a company level, but it kind of reminds me of last week and Nintendo, where I feel like there's just a lot of uncertainty. And it kind of feels like for Nintendo, that might be more to the upside. And for Hershey, you have to defend against the bear thesis. And I think you did quite a good job about that. And not because you were biased in any way, but I think because there are pretty good arguments to say that maybe the bears have taken over and the stock was beaten down too badly. But before we get to the variation part, there's one more thing that I want to talk about.

1:11:31And that's, and we kind of got to it, is the original character of Hershey's and the entire industry. And the fact that they still had an international segment and was growing quite fast. I think there was double digital growth for most of the time in the last couple of years. Now, the last year was a bit more tough, especially for what happened in Europe and kind of around the world with the Russia-Ukraine war. And if I'm not mistaken, I think they do want to stop investing more into the international business and kind of focus more on acquisitions in domestic brands. Do you have any knowledge of any acquisitions coming up?

1:12:09Or maybe I'm mistaken and they want to go about the international investments anyway. Robert Leonard Your guess is going to be as good as mine here. What I do know is that Hershey's loves to buy brands, which they've done with Dots and Lilies. And they really like to buy companies that specifically have about$100 million of sales, strong margins, and which could maybe benefit from Hershey's distribution and relationships with retailers and its large marketing budget. So the wonderful thing about Hershey's playbook there is that they're disciplined enough to mostly only bet on proven brands, yet they have enough advantage from their scale that they can further level up these still smaller brands and meaningfully grow their business by acquiring them.

1:12:52So if a brand has one value on its own, it almost instantly becomes more valuable when incorporated into Hershey's portfolio, because Hershey has the best relationships in the industry and the deepest pockets and a proven commitment to wanting to invest large sums into building these brands further. And of course, there's a litany of brands they could diversify into. My guess is that they'll continue to try and diversify into salty products or sugar-free confectionery products in particular, but we'll see. For them to grow their salty snacks division from$1 billion in revenue to$3 billion in the next few years, which is what management has said is their goal, that's going to take a lot of organic growth and also acquired growth to achieve.

1:13:36They definitely have the cash to keep making acquisitions with. And that can honestly be better sometimes than trying to build new brands from scratch. But because the trust that controls Hershey is so very conservative, and the fact that they try to pay out at least 50 % of their earnings as dividends, that does limit the size of the acquisitions they can do. So I don't expect anything major, but I'm sure they'll keep making them on the margins. They've said they want to be the number one consumer packaged goods company in the US. So with that kind of ambition, they're definitely going to need to keep snapping up valuable brands.

1:14:10That's true. So summarize, it sounds like we just have to wait and see. Now, I pitched it just a minute ago, and now it's your turn to kind of fit all of this into a valuation. And I mean, we have to do it. I know it's a difficult task, but we both of us, we sit here and all the companies we discuss, we want to come up with an intrinsic value for them. So now the stage is yours and you will show us what you came up with. Let's do it. I'll be the first to say that the company's Q4 2024 earnings give me a little bit more room to be optimistic than I otherwise would have been. Because before that, it looked to me like sales were set to keep weakening while margins would be really badly pinched by higher input costs.

1:14:52Don't get me wrong, some of that is still expected to happen, but it's probably not as bad as I first feared when I took a look at Hershey a few months ago. Given how the stock has mostly collapsed over the last 18 months, I would still be inclined to be extra conservative to ensure that we're not trying to catch a falling knife, to use that cliche. You're never going to be able to time the bottom with a stock, but you also want to make sure that you're not signing up for years of pain either. And on that note, with Hershey's management forecasting that gross profit margins will decline a whopping seven percentage points, while also net income falls off by something like 40 % this year, there's still pain left to be felt here.

1:15:35And I don't really trust kind of the bounce back that the stock has had since reporting Q4 earnings. Those realities are mostly priced into the stock, I'd imagine, maybe less so after the recent rally, but it's still a rough situation to enter into. And to be honest, I have a lot of trouble justifying the current stock price. In my model, I try to discount the cash flows over the next five years with some fairly optimistic assumptions around gross profits and operating margins normalizing after what we all know will be a bad 2025 and with some modest revenue growth. And I still got a share price target, at least as a fair value of$131 per share.

1:16:15And when I tried valuing the company based off of a range of plausible price to earnings ratios by 2029, which is another approach I often like to do with companies, I got a weighted value of$129 per share. And so the average of the two, maybe two conveniently, comes out to a perfect$130 between the two. And that is a decent discount to the already beaten down stock price at the time of recording, especially after it's rallied a bit. And to build in a bit of a margin of safety to hedge against things going worse than expected or that my analysis is off, I couldn't even really imagine touching the stock and being really, really excited about it, given the opportunity costs, unless we're at$115 per share or less, which is maybe laughably cheap to some people.

1:17:01But the reality is we're not obligated to buy any company. And to me, a significant decline is needed before I find Hershey's to be really attractive, which is kind of ironic that I'm pitching it, but it's always good to at least understand these companies so that in the next big sell-off, we're ready to act on it. And that could easily happen. And people may be shocked because not that long ago, the market valued the stock at$275 per share. So that's a pretty huge gap between what I see as an intrinsic value target, especially because Hershey has such great brands and all that stuff. But the reality is that this company's earnings are expected to nearly get cut in half this year.

1:17:42And things would have to reverse dramatically and quickly in the next few years for the stock to support the kinds of valuations where you could really argue that it's worth more than$200 per share. Otherwise, in my opinion, at least, the company needs to be revalued at this new normal where the high gross profit margins of the last decade can't be taken for granted, given the volatility we know can happen in cocoa prices and just the general inflation environment. From tariffs to unionized workers demanding higher salaries to offset the rampant post-pandemic inflation, you get these feedback loops that play on each other where the price of everything's going up and then workers want to get paid more.

1:18:23And then it's a destructive flywheel working against Hershey in some ways. So there are some real structural challenges that make Hershey fundamentally less profitable than even just two or three years ago, and especially prior to the pandemic. And it feels like I'm being harsh on Hershey, but I just couldn't find a way to play with the numbers, honestly, that didn't suggest its stock was still overvalued. So my fair value for Hershey is$130 per share. And like I said, if it dips below 115, I might revisit it and suggest it for the portfolio more seriously. And at that point, I'd have to account though for whatever news drove the stock to those new lows, which could change the picture.

1:19:04And as long as it's nothing long-term, like I said, I could be tempted to reconsider it, but I don't really feel compelled to own it either at these levels. So I've dumped a ton of info on you, Daniel. all. So why don't you tell me what you think? Is there anything I'm missing here or any reason we should consider for the intrinsic value portfolio? Well, first of all, if there's one thing that I learned in investing, it's that preparation is everything. I think the more we look at companies and the more companies we have on our watch list, the easier it will be to find the best investments. And I think today's pitch is one that goes into that direction.

1:19:39I think Hershey is a very good business that might not be as attractive at today's prices, but is definitely one to have on the watch list. And you know, I told you why I love deep dives. And today is an example for why, because you just learn so much about the business and so much about an industry and the dynamics, you know, that you usually just wouldn't know about, you know, the products when they're in the store and you see them. And maybe next time I eat a KitKat, I'll think about the production of chocolate. But that's kind of just why I love these deep dives. So getting to the evaluation, I agree with you that personally, I wouldn't think that this stock is an attractive investment if we are not a lot closer to maybe$115, maybe even a little below that.

1:20:24Personally, and from my experience, I do not like to buy companies where I feel like the surprises that could come in the future are more to the downside. And you made a great case for the Kokora situation. And to me, it just seems like there are a lot more negative surprises that could come to Hershey's stock and their shareholders than positive ones. I kind of feel like there's the potential for a relief rally, kind of as we've seen in the last couple of months and weeks. But over the long term, and that's kind of what we're building this portfolio for, we want to find companies that we could hold for years.

1:21:00I just see too many risks that for me personally make Hershey an investment that I wouldn't feel comfortable owning with. You know, there's also the factor that I try to avoid companies whenever possible that I personally do not consume products of. And I give my best to eat as little candy as possible. I mean, sure, if I go for candy, it is chocolate, as I mentioned, but I just generally do not feel good investing in companies that not align with my values. And maybe for some people who do know me from my research before, I know that I also talked about companies like Evolution. I'm fully aware there's some inconsistency here, but maybe it just shows that the Hershey case is not getting to my investor heart, right?

1:21:47So that's why I totally agree with you. All right. So there you have it. Our thoughts on Hershey. It was a pretty fun company to dive into. And I feel like I came out a little smarter on understanding brand power, even if Hershey's isn't itself a screaming buy. And the wonderful thing about this show is I can kind of pitch a company, we can talk through it. And as we work through it, if we realize it doesn't deserve a spot in the portfolio, it wasn't all lost. I have to admit though, that I didn't get as excited about Hershey as I normally do when researching companies. And to me, that was just a signal, kind of like what you said, Daniel, that the company just doesn't align with my values.

1:22:26And that's probably a really poor way to invest. But we all only get to go through this life once and we have to live with the decisions we make. And not to sit on my high horse here, but I don't feel great about being someone who owns a company that I know is significantly contributing to obesity and poor health globally. And there's more than enough companies out there to invest in where I don't have to kind of have that thought lurking in the back of my head. To be fair, Candy isn't evil, nor do I think Hershey is evil, right? It's just a group of people running a business. Everyone deserves a sweet treat every now and then.

1:23:04And they do a lot of wonderful things to support sustainable cocoa production. And the Hershey Trust does run some admirable nonprofits. Still, I'd be far more inclined to invest in Vital Farms, which is a company I covered a few weeks ago, just because they align much more closely with my personal values. And I think it's a great business. I really do not like to bring personal values into investing too much. So I'll try not to do that going forward. Because what feels good doesn't always make the most money. But in this case, the externalities produced by Hershey are actually plausible reasons to be bearish on the stock.

1:23:40They could be more closely regulated, fined, and sued for their contributions to America's health issues and the world's health issues. And the rise of GLP-1 weight loss drugs is in many ways a result of companies like Hershey's not being more closely regulated in the past from how they can market their products to the type of ingredients they use. So I kind of hate to end the episode on a sour note, but I refrained from sharing my personal thoughts on Hershey's until we had made a portfolio decision. And I tried not to let that bias me as much as possible. Yeah, like I said, I think a company is a net negative for society and isn't even attractively valued, then it's an easy pass.

1:24:16I also want to mention that if you're wondering how you can track the intrinsic value portfolio, we'll build on this show each week to see our position sizes and holdings. You can sign up for our free newsletter in the show notes below. We're at theinvestorspodcast.com slash newsletters. And you'll get weekly outlines of our company breakdowns, portfolio, and even valuation models for the stocks we cover. So with that, let me say thank you again, Daniel, for joining me. It's been a ton of fun. Hopefully you're not offended by my rant on big food companies. It sounds like maybe you agree. Without giving away the company you'll be pitching next week, why don't you just give us a little teaser about what listeners should expect?

1:24:55Daniel Schaaf Well, what I can say is that we will get another company at least as strong as Hershey's in terms of brand and pricing power. I do hope, though, that we see a bit more growth going forward. And I think that should be enough of a teaser. I think you know what to do. If you want to hear about it, just tune in next Sunday. Cool. All right, folks. That's all for today. Let me leave you with a quote, as always. Starbucks' iconic former CEO, Howard Schultz, reminds us that, quote, authentic brands don't emerge from marketing cubicles for advertising agencies. They emanate from everything the company does.

1:25:30To Hershey's credit, its powerful brand emerged from 130 years of nearly singular focus on chocolate and sweets. And that authenticity and focus ties back to its ambitious founder, Milton Hershey. So we'll be back again next week with another stock breakdown in valuation. See you guys then. Thank you for listening to TIP. make sure to follow the intrinsic value podcast on your favorite podcast app and never miss out on our episodes to access our show notes and courses go to the investors podcast.com this show is for entertainment purposes only before making any decisions consult a professional this show is copyrighted by the investors podcast network written permissions must be granted before syndication or rebroadcasting oculting.