Introduction

Hershey (HSY) has underperformed some of the larger food peers, primarily, as the company did not enjoy the quarantine sales boost that other peers had witnessed. Along with that, chocolates being primarily an impulse purchase with the consumers making fewer trips to the retail stores hurt the demand. Prior to the recent jump yesterday, the YTD returns were flat, in line with its closest peer, Mondelez. However, with the recent earnings beat, has the company finally turned the corner?

Earnings Corner

The company reported a decrease of 3.4% in sales for Q2 2020 compared to the previous year with volumes suffering a 7 point headwind due to COVID-19 induced lockdowns across the North American and International markets while price realization improved 3.5 points offsetting some of the declines. It was able to maintain gross margins at 46.4% compared to 46.5% as incremental manufacturing costs due to COVID-19 was largely offset by gains in price realizations. Adjusted operating profit margins increased 170 bps to 22.6% as a result of cost containment measures as well as a 14% decrease in advertising spends. As a result, the company posted a Non-GAAP EPS of $1.31 compared to consensus estimates of around $1.10 per share. The company also increased its dividends by 4% implying a dividend yield of 2.3%. The company did not provide any guidance for the rest of the year, however, it does expect an accelerated sales recovery in the second half of the year driven by continued elevated at-home consumption, price realization, the replenishment of retailer and distributor inventory levels, and recovering sales in food service and specialty retail channels.

Bears Take

Hershey Chief Executive Michele Buck alluded to the fact that COVID-19 pandemic could impact candy demand during Halloween season which makes up a tenth of the company's sales. Trick or Treating, which is primarily an outdoor event, makes up almost half of the candy sales while the other half is generated by the people buying candies for friends and family. While the management does not anticipate a sharp volume decline, it plans to make fewer Halloween-themed candies to avoid leftovers or to sell at discount. Holiday weekends do make up a bulk of the sale for the company and any dip in the volumes would pressure the sales significantly in the case of prolonged COVID-19 effects. However, the company had a decent Easter when the stay-at-home orders were in place and similar trends could be anticipated for the upcoming holiday season.

Investment Thesis

The company has been at the forefront of the lockdowns induced by the pandemic with fewer shoppers turning up. However, the company did turn the quarter in the second quarter highlighting its ability to drive sales growth in a difficult environment while keeping margin challenges at bay. Although the company did not provide any outlook, the second half of the year is expected to be more robust wherein the company underscored improving sales in the months of June and July. The company trades at under 23x PE (1-year fwd.) and given the improving business environment, stable dividend yield, and continued focus on innovation, this stock is a solid defensive play available at a reasonable price.