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 "Give them Quality, that's the best kind of advertising in the world"
- Milton Hershey

KEY STATIST ICS CO:\IP.-\~Y O\'ER\'IE\\': -

The Hershey Company (HSY), headquartered in Hershey, PA, along with its
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subsidiaries is the leading producer of quality chocolate in North America and
a global leader in chocolate and sugar confectionery. They sell and distribute
products under more than 80 brand names in approximately 70 countries
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including Asia, Europe, Middle East and Africa.
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The company is more than I20 years old and sells products including
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chocolate and confectionery, snacks, mint refreshments and gum, toppings,
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Ltrgct 1'11cc • .., '12 x, baking ingredients, and beverages. Still building on its core business, Hershey
Sh;1rcs Ouhta11J111g . • 221.04 is expanding its portfolio to include a broader range of delicious snacks, while
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Rcccnt 01\ 1Jcn<l: • .., 2 04 remaining focused on growing its presence in Key international markets.
IT\.\:\l'l.\l. SI RI· N< illl Hershey's business model focuses on high volume and low margin with
Ocht l'ap11;tl Rat1<1 . 4 UC majority of customer' s being wholesale distributors, mass merchandisers,
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chain grocery stores, drug stores, wholesale clubs, vending companies etc.
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Mclane Company Inc. is the prime distributor of Hershey's products to
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REC E~T PERFOR'.\l.\~CE: -
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During the first-half of the financial year 2014, Hershey's performance was
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below expectations due to irregular shopping behaviors, high competition in
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the confectionery industry, and changing macro environment and soft
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ln~t 11u1wnal <>wncr~h,p: international growth.
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In the third quarter, sales increased from a weaker first half due to the
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expected Halloween seasonal orders in North America. International sales fell
I Y car Larnmgs <irll\\·th short of management's anticipations as the dollar value rose in comparison to
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5 Y car Larnmgs ( irP\\ th other currencies. Moreover, the company continued to observe irregular
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patterns in store traffic and consumer trips in food channels in the U.S., which
decreased the sales of non-seasonal candy products unfavorably affecting the
company's product sales. Meanwhile, the radical increase in dairy costs this
year has sternly impacted Hershey's gross margins.

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 ··o ·· - - -· - nas Deen reV1sed four times due to
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results, softer international sales growth
. and increase
. .m commodity costs volatil1·ty It wea
3¾ 5¾ in . . expects a
o- o crease m growth from the previous financial year including dilution from ac . ·t·
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and d 1vest1tures. Even after slower growth., margins. have been relatively healthier than sales

supported by price increase, supply chain savings and productivity gains. Also, sales trends are
expected to improve in the upcoming quarter, which is backed by innovation, heavy
advertisement and superior consumer marketing. In the third quarter of 2015, the company
bought back shares worth $ 230 million under the$ 250 IDJ·t1 10n
· approva1.
Movement of Hershey's Stock Price over the S years: -

: I I I •

REC'E:v r '.\ E\\ S : -

• Hershey's offers Senior Notes (Aug 18, 2015): -

Hershey is recently offering 1.6% and 3.2% senior notes due in 2018 and 2025 with a
principal amount of$ 300 million to repay its debt of$ 250 million due in 2015.

• Hershey declares Quarterly Dividend (Oct 6, 2015): -

The company declared a dividend of$ 0.583 per share on its common stock, which will be
payable in December 2015.
• Hershey's New Chocolate Products for a Healthier Holiday (Nov 12, 2015): -
As a part of the competitive strategy Hershey's announced that it would launch Healthier
chocolates for the holiday season. This strategy is in order to be more transparent, so that
consumers can understand the simple ingredients used in the making of the chocolate.
Hershey plans to stop using GMO sugar, milk from cows treated with bovine growth
hormones, artificial colors and gluten. Hershey is currently working with innovative firms
such as Plantir Technologies to establish predictive analytical competencies in the areas of

consumer intuitions.

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 l~Dl'STRY A~AL\'SIS: -

The Confectionery market is made up of over 1,200 brands and approximately 1000 companies
with a combined annual turnover of$ 23.5 Billion and Market Capitalization of $341.21 Billion
in 2014. The total U.S Confectionery industry is expected to grow at a compounded annual
growth rate of 2.7% between 2015 and 2019. In the market, only 15 to 20 companies have
national distribution while the others enjoy only local or regional distribution. According to the
Statistics, Hershey and Mars are the major players in the chocolate market with 42% and 25%
respectively.

U.S. Total Confectionery Market Share: -

U.S. Chocelat• Market Share Measure

a The Her.,.y Co.

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In the industry, the threat of new entrants for Hershey's is relatively low due to the economies of
scale it enjoys. It is very difficult for the new entrants to establish themselves due to huge capital
investment, government regulations and to have access to distribution channels. However,
Hershey faces extreme threat in the substitute products and services due to several reasons. First,
as it specializes in chocolate, thus has to compete with other flavors such as vanilla. Secondly, it
also faces tough competition from snack industries such as Frito Lays.
The other concerns that affect the industry are the raw material prices. The federal law places a
limit on the production and import of sugar in the U.S. thus making the domestic companies face
tough competition with the overseas producers who incur less cost on the raw materials.
Also, the bargaining power of suppliers for Hershey' s ranges medium due to very concentrated
suppliers. As there are not many substitutes for the key ingredients of chocolates, the growth of
the industry largely depends on the suppliers.

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 The competition in North America from global confectionery giants such as Nestle and Cadbury
is mitigated through the licens ing agreements that Hershey holds. In case of both the competitors,
Hershey has exclusive licensing rights on l(jt-Kat and Cadbury brands, thus aiding it to dominate
the U.S. market.
As the companies have market commonalities and similar resources, the competition becomes
quite intense motivating them to get a competitive edge over the others. Hershey's with its
innovation comes out with altogether new product line, which Nestle or Mars haven't countered
as yet. Also. ROE of Hershey's was 55.4% in 2014 as compared to Mondelez's and Nestle's
ROE which was 7.3% and 21.8% respectively.

GROWTH DRl\'ERS: -

GROWTH DRIVERS: -
There are various reasons for Hershey's dominance in the U.S. Market, which are: -
• Strong Brand Image: -
Hershey has over 80 brands that include popular and classic candies, which are offered to a
diverse group of customers. Most of the company' s products such as Kisses, Twizzlers, and
Kit-Kat have been on the to p ten chocolates of all times thereby making a strong brand name.
The management believes in keeping the loyal customers than getting new ones. However,
due to brand awareness the new ones do get to know Hershey's brand. The company consists
of diverse brands that are not associated with the main Hershey's logo, thus even if one brand
fails the rest can keep working for the loss.
• Micro-Marketing: -
Micro marketing is a concept that means targeting certain products to small audiences and
tailoring them to meet their particular demands. Hershey aims to provide its customers with a
variety of range options by personalizing the products and selling them at a higher rate. Thus,
even with small sales it earns good margins and revenues. Some of the examples of
personalized products are arrangements for weddings, birthdays, baby shower etc.
• Improved Supply Chain Management: -
Hershey follows a demand driven model, which concentrates more on the core products. In
2010 and 2014, the company restructured its global supply chain operations, which resulted in
higher sales volume and created a competitive cost structure.

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• Constant Product Innovation: -
gain
The company constantly keeps introducing new product line to tajlor the needs of the
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competitive advantage over other brands. Consumer health awareness also drives the compan
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to make innovations. For e.g. Hershey launched a premium Brookside Fruit and Nut
which bas hlgh protein content and is free of gluten and artificial flavor.

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Along with the above growth drivers, there are many other merits of Hershey 's as well such
itors,
powerful partnerships with suppliers, relative low sales volatility compared to compet
strong customer relationships and high involvement in the community.

, ._\Ll' .\TIO:\ \IODEL S: -

of a
There are various models that are used in calculating the intrinsic value of the stock
,
company. Some of the famous techniques are Discounted Cash Flow model, Du Pont analysis
Price Earnings Ratio and PEG Ratio. Let us discuss these techniques in detail.
• Discounted Cash Flow Model: -
on
A discounted cash flow model is used to determine the intrinsic value of a stock, based
ne the
estimated future cash flows and cost of capital. The first step in the model is to determi
are
number of years of estimation and the cash flows for the same. In case of Hershey 's, we
For
predicting cash flows for two periods, which are I to 5 years and 5 years to perpetuity.
estimating the cash flows for the same we took certain assumptions that are: -
► For the year 2015, we have taken an annual earnings growth rate
of 3% on the Free

cash flows of 2014, as there are abnormal patterns of product consumption and
increase in commodity cost. Also, a slowdown in the China market can result in lower
revenues in compari son to the previous years. Moreover, there have been
controversies alleging the use of Child Labor for cocoa harvestation in West Africa.
► For years from 2016 to 2019, we have assumed a growth rate of 5.4% due to various
reasons that are: -
• First, as the Confectionery market is responsive to advertising, Hershey 's has
increased its budget for advertising, allocating 40% of it towards digital marketing. It
has also begun operating innovations like precision-targeted merua.
• Secondly, Hershey increased its capital expenditure in 20 I 5 to set up a confectionery
manufacturing plant in Malaysia to meet the growing demands in the region, thus
expanding its base in Asia as the geographical choice provides easy distribution

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 access to more than 25 markets across Asia. The plant is expected to generate annual
sales of$ 200 million to $ 300 million within first three years of operation.
• Hershey is focusing on improving supply chain operations as it would increase the
margins and result in cost savings. The company has the best cost per pound of
chocolate as compared to other companies. And since it has pricing power over the
customers, it can attract higher gross margins.
• As 30% of consumers in U.S. now prefer healthier snacks, Hershey's in 2015
acquired Krave Pure Foods Inc. to expand its customer base to faster growing
categories. This strategy can increase the sales of the company in future.
• Hershey is also operating on cost structures and different integration strategies to get
the Shanghai Golden Monkey business back on track as they see China as a
fundamental growth market. Moreover, to make the products more accessible m
China, the company has started to distribute to smaller parts of China.
• Also, the commodity prices of the raw materials used by Hershey i.e. Cocoa and
Sugar is going to decline in future. (Data extracted from Bloomberg, shown in
appendix)
• Hershey is also expanding its outlook in Organic Segment, as the demand for the
same is going to increase in the future. It has acquired Dagoba Organic Chocolate
LLC, a leading manufacturer of Organic Chocolate in order to increase their presence
in the growing arena.
• Even after so many growth prospects, we have assumed an average rate of 5% is
because, the Federal Reserve System might increase the interest rates which would
result in increase in the dollar rate thus reduce the sales from the international
segments.
► Lastly, we have taken a 4% growth rate till perpetuity, as few products would reach their
decline stage and for constant innovation the company would require more capital. Also,
there might be high competition from other manufacturers or new entrants.

After estimating the future cash flows, the next step is to find out the weighted average cost of
capital that requires cost of equity and after tax cost of debt. The WACC for Hershey for 2014
is 7.44%. (Calculation in shown in the appendix) Thus, discounting the future cash flows with
the WACC we got the Present value of the firm$ 145.71 Billion. We then have to add back the
abnormal gains, deduct the share of the debt holders and divide it by the number of outstanding
shares. We then get the intrinsic value of the stock as$ 64.62.

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• Price to Earnings Ratio
The Price-to-Earnings Ratio or PIE ratio has been used to measure Hershey's share price
relative to its per-share earnings. The trailing PIE ratio has been calculated over the past five
years and compared with snacks and confectionary benchmarks to find out whether Hershey's is
undervalued or overvalued.
During the past 13 years, the highest PIE Ratio of Hershey's was 58.01, the lowest was 18.55
and the median was 26.67. Its diluted earning per share for the trailing years ended in December,
2014 was $3.37. Therefore, the PIE ratio is 27.56 in 2014. HSY's PIE Ratio is ranked lower than
75% of the 1161 Companies in the Global Confectioners industry.
2010 2011 20 12 2013 2014
PIE 21 .33 22.54 24.98 26.93 27.56

Here we can see that the trailing PIE ratio is increasing over the past five years. While a high
PIE ratio may make a stock look like a good buy, factoring in the company's growth rate to get
the stock's PEG ratio can tell a ditlerent story.
The PEG ratio has been used to determine Hershey's stock value while taking the company's
earnings growth into account, and is considered to provide a more complete picture than the PIE
ratio. The lower the PEG ratio, the more the stock may be undervalued given its earnings
performance.

2010 2011 2012 2013 2014

PEG 0.9342 0.6147 0.8522 1.0536 1.0296

A PEG ratio above 1 indicates that the company's stock is trading at a premium to its growth rate,
or in other words is overvalued. Therefore, a ratio of 1.0296 implies that Hershey's stock is
overvalued based on its estimated future growth.
 model which is lower than the actual market price of $ 86.5. Therefore, Hershey' s stock is
overvalued since the market value is greater than the intrinsic value.

• Sensitivity Analysis
Sensitivity analysis has been applied to determine how changes in discount rate and growth rate
will impact the intrinsic value of Hershey' s stock under a given set of assumptions.
Particulars Optimistic Average Pessimistic
Discount Rate 3% 7% 10%
Growth Rate 8% 4% 2%

Here three different sets of discount rates and growth rates have been applied based on optimistic,
pessimistic and average macroeconomic conditions to find out the final intrinsic value of the
stock and decide on the overvaluation and undervaluation status in all possible economic
conditions.
Optimistic Intrinsic Average Intrinsic Pessimistic Intrinsic
Particulars
Value Value Value
Impact of changes in
70.6 57.9 40.7
Discount Rate
Impact of changes in
72.8 60.4 42.3
Growth Rate

The lower the discount rate, the higher the intrinsic value and again when the growth rate
increases to 8% due to favorable economic conditions, the intrinsic value gets better. In all three
situations, the intrinsic value is less than the current market price of $86.5. Therefore, the stock is
overvalued under all three economic conditions.
CO'.\Cl.l lSIO'.\: -

Overall, Hershey's strong brand pos1t1oning, strategic marketing investments in core

brands, disciplined innovation and consumer capabilities make it attractive. It is also
actively targeting high-potential overseas markets such as China, India, and Mexico.
While China and Mexico featured in the top IO markets for retail confectionery sales last
year, India is expected to touch $2.2 billion in 2018. So, despite its temporary run of bad
fortune, Hershey's still has a lot going for it, likely revenue and earnings growth in
coming quarters, market expansion strategies, and sustainable high yields.
According to our financial models, the stock of the company is overvalued and we recommend to
Hold the stock as the stock could perform well in the future. Since Hershey's is making frequent
M&A and targeting some high potential and profitable foreign markets, we are predicting that
stock price will go further up, and in that case investors will be able to sell off their shares at a
higher price by deciding to [Link] these shares for some time.

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