Tuesday, June 13, 2006

Hershey's Faces Cost Pressures, Shares Jump

Shares of Hershey's (HSY) are up 6% in the 4 months that have elapsed since we told investors to pass on the confection giant (see here). Shares have run up because of the recent inflation scare, which has sent a pile of cash into "safe" stocks, like cereal and beverage plays. What's striking is that Hershey's is by no means a safe or defensive stock, at least not in the traditional sense.

Because HSY essentially makes candy, people assume that not even a bloody recession'll hurt the stock; if your unemployed, you'll probably still shave, buy Kleenex, and munch on Kit Kat bars -- or the thinking goes. The problem as we see it is that Hershey's is deeply levered to commodity + raw material costs, such as the price of sugar and cocoa, resulting in a fractured bottom line.

The current valuation isn't doing much for us, either: At 27 x trailing 12 month EPS, Hershey is swapping hands at a premium to its historical 5 and 10 year P/E averages. On top of this, sales are growing less than 1% (market saturation; only 11% of sales are outside the US) and cost pressures have turned off a large portion of investors. Insiders are telling analysts that 2006 EPS will jump 9%, but at the current multiple as well as the volatile raw material environment, we're simply not convinced that shares represent an attractive risk/reward.

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