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Is Hershey the Value Play of the Year?

Thursday, February 28, 2008 | Wayne Mulligan

A great question appeared on TickerHound the other day that really caught my eye. One of our members asked:

Is Hershey going to be the biggest value play of the year?

This has to be something Buffett would be licking his chops over - and not just because the chocolate is good - Hershey looks like Coke did back in the 80's. Getting hit by competition and internal problems, but still has this ridiculous amount of brand equity and consumer reach.

My only question is, when do we buy?

Click here to read some of the answers or submit one of your own.

Being that I’m a chocolate fanatic and an avid Buffett follower, the question immediately had my attention – I was even tempted to post a quick answer to it, but I decided to dig a little deeper and do my homework on this one.

Full disclosure: I do NOT own any shares in Hershey or any other company I discuss in this article.

So the story behind Hershey’s recent decline is this:

Back in January of 2007, Hershey’s CEO at the time, Richard Lenny, met with his counterpart from Cadbury, Todd Stitzer. Stitzer was proposing a merger between the two consumer food & beverage giants that would create a global candy making powerhouse.

Cadbury was willing to give up its beverage business (a huge point of contention between the two companies in the previous merger discussions they’ve had) as well as incorporate in Delaware, maintain a US stock listing and keep the headquarters in Hershey, PA.

Somehow, after that meeting, Mr. Lenny got into a major dispute over the merger with Hershey’s largest shareholder – The Hershey Trust Co.

The Hershey Trust was formed by the company’s founder, Milton Hershey, as a school for orphans which he eventually transferred all of his assets to, including his stake in Hershey’s chocolate. The trust currently owns almost 30% of Hershey’s stock, controls 79% of the voting shares and can remove 5/6 of the company’s board if it saw fit to do so… in fact, that’s exactly what they did do, as well as force Mr. Lenny out along with a number of other top ranking executives.

They say it had to do with Mr. Lenny’s withholding information about the proposed merger and Hershey’s growing financial problems. This is all disputed by a number of parties on both sides of the fence, so I won’t go into it here.

Now, the stock is down 31% in the last 12 months – the stock hasn’t been this low since 2000 – 2001.

For me, when a brand name like Hershey’s is getting beaten up in the market, it smells like an opportunity to make some money. So here are the pro’s and con’s for Hershey as I see it.

Positives:

  • Largest candy maker in the US
  • One of the strongest consumer brands in the country
  • Aggressively moving into global markets
  • In the process of integrating a massive overhaul of its supply chain in order to improve efficiency and reduce costs
  • Stock has been hit hard and is at historically low prices

Negatives:

  • 80% of its sales come from the US
  • Brand reach doesn’t extend outside of the country
  • International probe from US, Canadian and European regulators into whether Hershey (and several other candy makers) engaged in a concerted price fixing scheme
  • Revenue and profits fell short in 2007
  • Recent management and board shakeups have left the company in untested hands
  • Still going to see roughly $200 million in operating charges next year in relation to its supply chain overhaul

Potential Outcomes

So the negatives seem to be outweighing the positives… for the moment, at least. The chart is in a solid downward trend and, while it might’ve found support where it is now, I can’t see it moving dramatically to the upside anytime soon, especially with all the other uncertainties surrounding the company.

The new management and board have me concerned as well. Reason being: the folks who control Hershey’s Trust are all local Hershey, PA elites – not veterans from the candy business. It doesn’t give me that “warm and fuzzy feeling” knowing that the largest shareholder is making such dramatic changes based on one bad year and for feeling like they’ve been kept out of the loop.

So to answer the original question – the time to buy is not right now. I’d wait until this stock builds a base and starts trending upward. However, if you’re already a Hershey shareholder, I wouldn’t be too alarmed at the moment. We’re still talking about the largest candy maker in the US with one of the oldest and most powerful consumer brands in the country.

If the company doesn’t recover on its own, here are some other potential outcomes that will help shareholders see some serious upside in the stock:

  • Merger with Cadbury: The Hershey Trust isn’t opposed to a merger with Cadbury – in fact, as they were planning to shakeup the company they held additional talks with Cadbury in New York late last year. While the two companies didn’t come to an agreement, I don’t see why the conversation couldn’t be picked up again, especially if Hershey’s stock continues to languish.
  • Merger with Wrigley’s: A few years back Mr. Lenny architected a merger with Wrigley’s, the gum maker. Again, Hershey’s Trust nixed the merger at the last minute. But again, if the stock continues to languish we could see some of these conversations pick up again.

At the end of the day, I think it’s fairly clear to all parties that Hershey needs to diversify its business away from the US market. They need a partner overseas, especially in Europe, and Cadbury would be a fantastic fit in my opinion.

So while I wouldn’t be a big buyer just yet, my guns will be locked and loaded because at some point in the not-so-distant future, Hershey’s stock will become a part of my portfolio.

Click here to read some of the answers or submit one of your own.

Wayne Mulligan
Contributing Editor
The Tycoon Report
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