Hershey shares to rally on lower cocoa prices, other cost savings, analyst says

Published Fri, Jan 6 201710:25 AM EST

Credit Suisse on Friday upgraded Hershey to outperform from neutral, citing the potential for the candy maker to significantly reduce expenses and prove it was right to deny a takeover attempt last year and go it alone. "After more than two years of missing expectations due to disappointing results and after rejecting a takeout offer from Mondelez, Hershey's management is under a fair degree of pressure this year to prove to the market that it can achieve above-peer returns as an independent company. We believe that it is set up to do exactly that over the next 12 months," equity analyst Robert Moskow wrote in a note to clients. Strong confectionery sales in the U.S. last year, falling cocoa prices and a "more realistic outlook for growth," could mean the Street revises Hershey's earnings estimates higher in the upcoming quarters, Moskow said. "After taking a longer time than its food peers to adjust to the slowing growth environment, management is now operating with a much more aggressive approach toward its cost structure separating the 'nice-to-haves' from the 'need-to-haves.' By our math, these steps will improve Hershey's adjusted overhead costs by over 100 bps [basis points] in 2016," Moskow said. Because overhead costs for Hershey have been above the average for the food group, the analyst believes there's further room for improvement. Moskow points to operations in China as an example of how costs could be minimized: "In China, for example, it has been spending on SG & A [Selling, General, and Administrative Expenses] at a run-rate of perhaps $100M when it probably only needs $25M to be a viable business for the long term. Even if cost cutting in China negatively impacts sales, we can still see a pathway to $50 million of savings, which would account for almost half of the profit growth in our forecast for Hershey overall." Similarly, he thinks Hershey could save on advertising expenses by switching to digital and using a more targeted approach. Product innovation and expansion within the confectionery business should also improve, which could lead to higher sales, Moskow predicts. "We conservatively estimate that management will guide to 3 percent growth in 2017 (with the International division providing a modest benefit) representing the low-end of the company's 3-5 percent long-term growth target," the analyst said. In the past year, shares of Hershey are up 18 percent compared with a return of 9.5 percent for the S & P consumer discretionary sector. Hershey, 1 year Source: FactSet A 30 percent drop in cocoa futures prices from the high last year could translate into $200 million in savings for Hershey's production costs, according to Credit Suisse's estimates. Since Hershey's hedges its cocoa reserves for at least 12 months, analysts at the firm expect the company to begin to benefit in 2018. At current levels, Hershey's stock trades at 23 times forward earnings, a valuation premium of 14 percent above its peer group, compared with 16 percent historically, according to Credit Suisse. In the next 12 months, the investment firm predicts shares of Hershey could trade as high as $117, implying a gain of 13 percent from Thursday's close.

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"After more than two years of missing expectations due to disappointing results and after rejecting a takeout offer from Mondelez, Hershey's management is under a fair degree of pressure this year to prove to the market that it can achieve above-peer returns as an independent company. We believe that it is set up to do exactly that over the next 12 months," equity analyst Robert Moskow wrote in a note to clients.

Strong confectionery sales in the U.S. last year, falling cocoa prices and a "more realistic outlook for growth," could mean the Street revises Hershey's earnings estimates higher in the upcoming quarters, Moskow said.