Hershey

Hershey's second-quarter organic sales rose 3.6%, as inflation-driven price hikes offset lower volumes. In aggregate, higher prices, cocoa cost deflation, and efficiencies trumped stepped-up logistics costs and unfavorable mix, resulting in a 350-basis-point lift in adjusted gross margins to 41.6%.

Why it matters: Even amid an uncertain geopolitical landscape and subdued consumer spending, we attribute Hershey's stout marks to its investments in consumer-valued innovation and marketing to support its leading share position. The one blemish was in North American salty snacks (14% of sales, up just 0.6% organically), as executional issues limited its supply. However, we posit that, with automation and capacity coming online between now and 2027, these challenges will prove to be transitory. Our forecast calls for Hershey to invest 7% of sales in research, development, and marketing (about $950 million), and another 4% in capital expenditure ($575 million), each year through fiscal 2035.

The bottom line: Our $228 per share fair value estimate for wide-moat Hershey holds. With the stock trading at a 20% discount to our valuation, we'd suggest investors indulge in shares. We surmise the market's concerns around the volume impact that could materialize due to consumers' penchant for healthier fare and their unwillingness to pay up for more discretionary confectionery offerings are overzealous. In our view, Hershey's strategic playbook—anchored in extracting costs to feed investments in its brands—is prudent and should ensure that its dominant standing is unwavering.

Between the lines: Cocoa inflation has cooled to $5,100 per metric ton, which is down more than 50% from the April 2024 peak.

Even though management attests to possessing good cost structure visibility into 2027, we believe that Hershey maintains an arsenal (surgically raising prices, unlocking cost savings, and adjusting price packs) to blunt any lasting hit to margins if cost pressures surge.

Marrying Hershey's second-quarter results (6% organic sales growth and 450 basis points in adjusted operating margin gains to 20.2%), revised fiscal 2026 guidance (3.25% organic sales growth at the midpoint and $8.36-$8.52 in adjusted EPS), and time value, we're bumping up our fair value estimate to $230 per share, from $228. Our revised valuation implies a fiscal 2027 EV/EBITDA multiple of 17 times.

The bite from cocoa inflation has started to ease as the benefits of higher prices and cost-saving initiatives take hold and costs retreat. We expect Hershey to remain diligent, investing to ensure its mix keeps pace with evolving consumer trends, rather than relying on price hikes. Our long-term forecast continues to call for around 3%-4% average annual sales growth (2026-35) and operating margins that hold in the low-20s on average through fiscal 2035 (generally in line with historical averages).

With a sound strategic playbook centered on driving efficiencies to fuel brand spending, we believe Hershey is poised to maintain its competitive position over the long term. And while Hershey has been intentionally rationalizing its mix (unquantified), we view this as a judicious means of ensuring it focuses its resources on the highest-return opportunities. In our view, this is particularly critical in light of the rapid evolution of consumer trends and the intense competition that prevails.

Beyond working to prop up sales, Hershey now targets the removal of $400 million in pretax inefficiencies by the end of fiscal 2026 (up from $300 million previously), on top of its prior aims for $150 million-$175 million in costs (which, when taken together, equate to a mid-single-digit level of cost of goods sold and operating expenses). These savings are expected to be realized as the firm continues to digitize and automate more of its operations and to optimize its procurement and manufacturing networks. Further, the firm is pursuing tech-enabled productivity by embedding AI across sourcing, manufacturing, and distribution, targeting $110 million in run-rate savings. We view this pursuit as helping it offset unrelenting inflationary headwinds. Furthermore, in the face of outsize cost pressures, we believe Hershey will also adjust pack sizes and launch consumer-valued innovations to justify higher prices. This underpins our forecast for gross margins to average in the mid-40s through fiscal 2035 and for spending 6.5% of sales (more than $950 million) annually to support its brands and entrenched retail relationships.

In our view, Hershey's solid intangible assets (which also contribute to a cost advantage) warrant a wide moat rating, underpinned by dominant market share on its home turf, leading brands, and vast resources to support its brand standing and to expand and enhance its capacity. We believe these factors have enabled Hershey to become a critical partner for retailers that are reluctant to risk costly out-of-stocks with unproven suppliers. When taken together, we expect the firm’s returns on invested capital to remain comfortably above its cost of capital over the next 20 years.

Hershey’s dominant position in the US confectionery industry is illustrated by its 35% share of the domestic chocolate aisle, which outpaces the less than 27% share held by its closest competitor, privately held Mars, and just a low-single-digit share for private label (according to Euromonitor). Further, Hershey has continued to build on its market-leading position, gaining more than 300 basis points of share since 2017. These share gains have been driven by the number one US chocolate brand, Reese’s, which now holds north of 17% of the market, up from 12% in 2016, as well as its namesake label, which controls 12% of the US chocolate market. We believe this indicates that consumers are reluctant to compromise on taste and therefore prefer to stick with trusted brands, particularly when indulging.

Given retailers prefer to stock leading brands that can help drive traffic into their outlets, rather than unproven suppliers that likely lack the resources to meet supply chain needs, we believe the firm’s portfolio mix shift to include more on-trend categories, such as wholesome snacks following the acquisitions of Amplify (Skinny Pop), Pirate Brands, Dot’s, and LesserEvil, has been prudent. We surmise that Hershey’s brand prowess, retail relationships, and vast resources have been a catalyst for the market share gains these acquired brands have achieved. In that context, Skinny Pop now controls almost 25% of the US popcorn aisle, more than double the 11% held in 2017, when it was a stand-alone business. Furthermore, Dot’s has grown to become the second-leading player in the US pretzel category, with a market share of 20%, up from 1% in 2018 and less than 6% in 2020.

Beyond its stout retail relationships, we also think Hershey’s ability to hold and grow its share is a byproduct of the extensive resources it directs to support its brands, with around 6% of sales being funneled annually to research, development, and marketing on average over the past five years, or about $600 million. This not only brings excitement to the aisles where it plays but also helps keep its brands and products top of mind for consumers, who have many alternatives to satisfy their snacking cravings.

From our perspective, Hershey's brand advantage has contributed to a cost edge, which should enable it to fund investments in its leading brand mix to a greater extent than new entrants with limited budgets. This scale manifests in production and distribution advantages across its expansive network. We believe this creates a virtuous cycle, starting with scale that enables manufacturers to build mutually beneficial relationships with retailers. Through this, the vendor becomes an essential retail partner, developing sales strategies to maximize volumes and retailers’ margins, while also prioritizing its own brands. With a broad domestic manufacturing and distribution network, we believe Hershey operates with lower unit and distribution costs, greater supply chain efficiency, and an enhanced ability to leverage brand spending, compared with its smaller peers. Furthermore, we posit that this cost position enables Hershey to replicate competitive products and offer them to retailers at lower prices than its smaller peers. This stands to limit the potential shelf space (and scale) that new entrants can amass.

Despite disparate disclosures, we’ve attempted to hone in on direct operating costs (manufacturing and distribution), while removing discretionary operating costs such as advertising and research and development, non-cash costs including depreciation and amortization, and nonrecurring expenses to gauge which firms are best positioned to overcome customer acquisition costs. In this context, we find that Hershey boasts direct operating margins above the industry average (33% versus 26%). As further evidence of the strength of its competitive position, returns on invested capital, including goodwill, have consistently exceeded our 7% weighted average cost of capital estimate by about 3 times, averaging 21% over the past five years. We forecast that ROICs will average in the low-20s over the next 10 years, supporting our stance regarding the firm's wide economic moat.

Although much consternation continues to swirl around the impact of anti-obesity drugs on the demand for the indulgent snacking and confectionery fare within Hershey’s product suite, we see the effect as muted. Even as further increases are likely, we believe Hershey’s vast resources and extensive data and analytics capabilities should enable it to adjust its portfolio to align its mix with evolving consumer trends, minimizing any volume impact.

Hershey is pursuing tech-enabled productivity by embedding AI across sourcing, manufacturing, and distribution, targeting $110 million in savings, which is slated to be reinvested in its brands.

Low-priced competition is scarce in the US confectionery aisle, as private-label fare holds just a low-single-digit share of the chocolate category, lagging Hershey's 35% share.

The firm's One Hershey commercial model should incite gains through a holistic portfolio selling approach, particularly as Hershey expands the placement and distribution of its underpenetrated snacking fare.

Unrelenting pressure on consumer pocketbooks could dent purchases of more indulgent and discretionary categories, such as confectionery and snacking.

More than one-fourth of its global employees are covered by collective bargaining agreements. Labor constraints could impede Hershey's operations, as three-fourths of these contracts are renegotiated in fiscal 2026.

Cocoa costs have abated off recent highs, but Hershey is still facing higher costs this year, as it had locked in supply in advance of the retreat.