[00:02:43] Daniel Mahncke: Yeah, sure. First of all, I maybe should mention that I’m far from being an expert on candy. You know, it’s not really part of my diet and I try to avoid it whenever I can. I do love chocolate though, so if I get weak, it’s definitely me eating chocolate at home alone.

[00:02:58] Daniel Mahncke: I was a bit surprised to see that one of my favorite chocolate ever is also part of Hershey’s portfolio, which is Kit Kat. And I must admit you just called it a global brand and me coming from Germany, I do not know most of the brands. Kit Kat is really like the one example that I, you know, that’s everywhere in, in every store and reason.

[00:03:17] Daniel Mahncke: This is also pretty much in every store you set foot in. But apart from that, I couldn’t remember to to see any of the other brands that Hershey has in its portfolio. So I do think there’s still a regional component. As you know, Germany has its own huge candy like Haribo, maybe some know that, and that’s huge here in Germany.

[00:03:35] Daniel Mahncke: So yeah, we’ll learn a lot about Hershey today from you. And I also looked into the business a little, and I was surprised to see that they actually have margins. I think they have gross margins that mostly remain flat at 45% over the last decade. And operating margins that have actually increased from 19.6% in 2015.

[00:03:57] Daniel Mahncke: To nearly 23% today, which is pretty astounding because I know that cocoa prices, they’ve almost tripled at times last year. So that should be a huge problem to Hershey. I do still know that their stock didn’t like those cocoa prices at all. I think it’s now down 36% for all time highs. Beside their stable margins, they have a 3% dividend yield, which is always pretty attractive.

[00:04:21] Daniel Mahncke: They have a strong 15% free cashflow margin, which is also not easy to find, and they show more than 20% returns on invested capital over the last five years. And you know, return on invested capital is such an important metric that I think every company that shows such a high quality should definitely be looked at in more detail.

[00:04:41] Shawn O’Malley: You’re exactly right, the picture is very mixed with Hershey. On the one hand, you have this legacy of success and these brands that aren’t going anywhere. Yet. On the other hand, you’re getting pinched from both ends in some ways with higher input costs that you alluded to with the cocoa prices and then some fall off in demand.

[00:05:01] Shawn O’Malley: And it is funny because despite all the bluster about the GLP one, weight loss drugs, from what I’ve heard from the company’s management, they actually think most of the weakness in customer spending stems from people responding to inflation by switching to knockoff brands and private label products.

[00:05:19] Shawn O’Malley: I’ve got a quote here from Hershey’s, CEO that I’ll just read on the impacts of GLP one drugs, but he says, so we would say we’re seeing a mild year on year impact. I’d say consistent with what I think we’ve shared in line with what we would expect, which I would say is a more gradual impact. We’ve continued to see multiple sources of data validating that the consumers of these drugs are eating disproportionately less of our categories.

[00:05:44] Shawn O’Malley: We are carefully monitoring that behavior, how it’s evolving, and certainly understanding what the needs are of those consumers so that we can continue to evolve our portfolio. And you know, that is fairly ambiguous. But I guess for me, the takeaways of the fears about the GLP one drugs, at least for the time being, are maybe a bit overblown.

[00:06:04] Shawn O’Malley: And the slowdown, at least if you believe management is apparently primarily from consumer weakness. The question then is whether that is unique to their business or emblematic of perhaps a broader recession that is looming in the economy. And either way, you can see why Hershey’s stock has been absolutely hammered over the last year or two.

[00:06:25] Shawn O’Malley: Right? Competition from lower price snack brands, GLP one drugs, structurally reducing the amount of snacks being consumed, namely by Americans, and a rollercoaster ride in cocoa prices. And all of that is obviously a recipe for pain. For the last year and a half, the stock has pretty consistently been setting new 52 week lows, despite some brief rallies more lately, and at this point it might be what you’d call a falling knife and trying to catch that is always pretty dangerous.

[00:06:54] Shawn O’Malley: It could finally be bottoming out or maybe it has another 30% to go. I mean, who knows, right? It’s always anyone’s guess and figure out what happens next is of course the hard part of investing, but the stock peaked at $275 in May, 2023, and it’s mostly been downhill since then. I think as you mentioned though, the business remains pretty profitable and it has managed to reduce its share count by around 9% over the last few years, so they definitely continue to turn off enough cash to reinvest in their business, but also to service debt and repurchase shares.

[00:07:28] Shawn O’Malley: With over $4 billion in net debt. Though I do find Hershey to be a bit highly levered, which I think we’ll talk about later, but it is really a concern for a company that is facing the sort of serious headwinds that Hershey is.

[00:07:42] Daniel Mahncke: It is. It is. And it’s interesting that you mention GLP one drugs so often. I don’t know if it’s just me not being the target group for those mets or if it’s just an American thing, because I feel like in Europe it’s not a huge thing.

[00:07:55] Daniel Mahncke: But I was surprised to hear management saying that it’s not a big factor yet. And so maybe you could talk about something that is a big factor and that’s the cocoa prices. Will that be a bigger problem going forward, or do you think they have a way to handle that?

[00:08:11] Shawn O’Malley: Yeah, so I guess just to maybe take a step back. Let, let’s get into it. With the cocoa prices, they hit a low in 2023. And then basically from there, it’s been all up. They hit a high of $14,000 per metric ton this past December, and that has mostly been tied to poor weather in West Africa, which is really damaged supply for growers in Ghana and Ivory Coast, which are the two largest producers of cacao beans.

[00:08:38] Shawn O’Malley: This caused cocoa supplies to be permanently impaired in a region that produces 70% of the world’s supply. So at the same time, sugar costs have been a bit higher than normal too. And as a result in November, Hershey had to cut its outlook for sales and earnings growth. The company’s chief financial officer has said previously that cocoa would be the biggest piece of the firm’s cost inflation in 2025, and I think it’s really important that we understand cocoa a bit better here since this is such an important input for Hershey’s.

[00:09:11] Shawn O’Malley: Obviously, cocoa is a shade grown crop, native to Mexico. And its consumption dates back more than 3000 years actually to when the Maya Toltech and Aztec peoples cultivated cocoa trees, which I didn’t know and and found really interesting. After the Spanish conquistadors arrived on the scene in the 16th century, cocoa soon spread to Europe and the Italians created.

[00:09:34] Shawn O’Malley: So the first chocolate sweetss with sugar, and then later countries such as Ghana and Ivory Coast, and Indonesia became the world’s largest producers of cacao beans, which has left Mexico now as the 14th largest cocoa producer in the world. So there’s some cocoa trivia for you, and it goes without saying that chocolate has been obviously one of the biggest food phenomena of the last 500 years, right?

[00:09:58] Shawn O’Malley: I mean, there are people who would probably tell you they can’t live without chocolate. In the world of food innovation and desserts, chocolate is like the iPhone. We basically have an entire holiday now devoted to kids walking to their neighbor’s houses, wearing costumes, and then just demanding chocolate, right?

[00:10:16] Shawn O’Malley: And moving on to the next. And it’s fully deserved if you ask me fully deserved, right? Yeah. In terms of how chocolate is actually produced though, the process goes, I guess, something like this. Cocoa pods are harvested from cacao trees, and the cocoa beans are fermented for two to seven days, basically just to develop flavor, and then they’re dried, and from there they’re roasted, which leaves behind only these little cacao neves, which maybe you’ve seen before.

[00:10:42] Shawn O’Malley: And, and those are ground into a paste called cocoa liquor, and then they’re pressed to separate the cocoa butter from cocoa solids, and then mixed with these other ingredients like sugar and milk powder to form what we would recognize today as chocolate, especially milk chocolate. Through that divine process, as you might call it, these really bitter cocoa beans are turned into a smooth.

[00:11:07] Shawn O’Malley: Delicious luxury for our taste buds. And I’m glad that somebody figured out how to do this. Of course, the problem for Hershey and chocolate lovers everywhere is that cocoa production is really highly vulnerable to climate change and severe weather has increasingly disrupted these supply chains for cocoa.

[00:11:24] Shawn O’Malley: There’s a report from the Guardian that says, quote, the future of chocolate is in doubt and a profusion of issues is significantly denting harvest worldwide. The climate crisis, which brings increasingly volatile and extreme weather, is hitting yields as rainfall patterns change and river levels shift.

[00:11:42] Shawn O’Malley: While hopes that genetically modified organisms could save chocolate, have yet to bear fruit even if such a breakthrough does happen. Technological advancements have helped create cocoa trees resistant to a destructive fungal bacteria. A broader intergenerational crisis looms as young people increasingly migrate to cities, leaving farmers with fewer children to follow them and learn the knowledge of cocoa production.

[00:12:07] Shawn O’Malley: So that was from The Guardian. And not to be too apocalyptic for any of my fellow chocolate lovers, but in 2018, the US National Oceanic and Atmospheric Administration said something similar and basically warned that much of the world’s cocoa tree production could be eliminated by 2050 as cacao trees potentially go extinct.

[00:12:30] Shawn O’Malley: And you know, I’m always w of these sort of far off dramatic predictions like that because sometimes it’s just kind of headline bait, but the point remains that the world’s supply of chocolate is in peril. And that is a big problem for a company like Hershey that obviously relies on selling affordable chocolate based trees.

[00:12:50] Daniel Mahncke: And it’s a huge problem for me too. I just mentioned I’m one of those fellow chocolate lovers. That’s really the one tweet that I still need. And you sound like a pretty, pretty much an expert on that now. And I think it’s always like interesting to see how much is actually going to the process of something that we see every day, that we taste every day.

[00:13:09] Daniel Mahncke: We do not really think about how much it actually takes to get a cocoa bean to, to actual chocolate that we buy in the stores. And it also shows you how complex that is. And usually I tend to say, well, probably we would just get it done with technology, but as you outlined, it might not be that easy. I think there might’ve been a price shock that was causing these immense price hikes in last year, but all of this sounds like there’s a more structural problem.

[00:13:37] Daniel Mahncke: And this might not be a one time event, but something that could repeat and repeat in the future. And regarding that, I do know that the business fundamentals didn’t look that bad last year. To me that begs the question, what did Hershey do to hedge against those costs? And also, are those long-term solutions or is it just a quick fix that worked for Hershey last year but is not helping them If prices should be higher for longer.

[00:14:05] Shawn O’Malley: A meaningful part of Hershey’s business depends on their ability to hedge commodity prices.

[00:14:11] Shawn O’Malley: And mostly that’s, that’s cocoa, but also some other things like sugar and foreign currencies too, right? Because they’re, they’re generating these chunks of revenue from all over the world and their exchange rates for dollars can fluctuate pretty significantly, which impacts the earnings they report in dollars.

[00:14:29] Shawn O’Malley: As of last September, Hershey had I think roughly $150 million in notional exposure to commodity futures contracts, and another $130 million worth of these foreign exchange contract hedges. So the significant parts of their, their balance sheet are being used toward hedging these different exposures on a recurring basis, and basically hedging commodity prices helps to stabilize their input costs, which directly impacts the measurement of cost of goods sold and gross profit, which you talked about earlier, being so stable and actually their operating margins improving over the last few years, and to further offset that rise in cocoa prices.

[00:15:10] Shawn O’Malley: The company has had to raise prices though too, right? And, and so I think, you know, over the last few years, at least in 2024, we saw a 67% price increase across almost all of its chocolate products to address for what they can’t completely hedge away. So you do have some amount of price increases that ultimately ripple through to the consumer.

[00:15:31] Shawn O’Malley: Though Hershey tries to absorb a lot of that before they pass it on, and by some estimates at least cocoa costs consume 20% of the company’s total cost of goods sold. So those fluctuations in cocoa prices where, you know, from one year we’re at a low to the next year, we’re at an all time high. And the associated hedging costs to reduce that impact can have real impacts on the company’s overall profitability.

[00:15:57] Shawn O’Malley: I guess unsurprisingly, Hershey ends up being such a massive purchaser of chocolate that they can move market prices for cocoa to try and hedge costs in 2025, Hershey recently asked the US’ top dedos regulator for permission to purchase a truly enormous amount of cocoa through the New York Mercantile Exchange.

[00:16:18] Shawn O’Malley: And there’s a report from Bloomberg that says basically that the company wanted to order 90,000 metric tons of cocoa on that futures exchange, which is the equivalent. And this is a cool set of 5,020 foot containers of cocoa. And that is more than nine times the size of the current maximum order that that exchange regularly permits.

[00:16:41] Shawn O’Malley: So if the question is, you know, how is Hershey dealing with hedging these costs? Well, you know, they’re doing it in a, in a big way. And, and the takeaway really is that hedging only goes so far, though they can’t hedge a hundred percent of their supply needs, otherwise, they’re showing up with 5,020 foot containers at the futures exchange.

[00:17:02] Shawn O’Malley: And even if they could, as old contracts fall off, you have to initiate new hedges around current market prices. So eventually, if cocoa prices remain high enough for long enough, there’s just no way of getting around that those higher costs have to be felt either by the company or by the customer, or by both.

[00:17:22] Shawn O’Malley: And for 2025, since much of the sting in 2024 was hedged with prices from 2023, this is when we really start to feel the pain from higher cocoa prices, which is why earnings are expected to meaningfully decline this year and why sentiment around the company has soured a bunch. Besides hedging, though Hershey has undertaken some longer term focus initiatives to invest in their supply chains, which I think are interesting.

[00:17:48] Shawn O’Malley: One of the programs is called Cocoa for Good, and it’s promised to invest over $500 million, apparently over 12 years, into ensuring sustainable cocoa production. Through partnerships with a number of non-profit groups and government organizations, they have all kinds of programs focused on generating more income for farmers, getting them to embrace more sustainable practices, and then discouraging them from using child labor.

[00:18:15] Shawn O’Malley: And basically, if farmers follow the better practices that Hershey requests, then they’re eligible for higher compensation, which supports a higher standard of living that should enable them to further uphold various sustainable agriculture goals. And that’s all very promising. And I don’t think they’re just PR stunts either, right?

[00:18:33] Shawn O’Malley: That world’s production of cocoa is, is plagued by not only disease and climate change, but also impoverished communities and child labor. So there is a genuine interest in improving the stability of the areas that Hershey relies on for its cocoa supplies. And it’s honestly necessary in some ways to invest in these communities so they can continue to attract future generations of farmers.

[00:18:54] Shawn O’Malley: Otherwise, you’re gonna have lasting damage to the soil under the cocoa trees, which is how you get a situation where cocoa trees might go extinct by 2050. So again, I don’t think this is just PR sense. I, I really do believe this is, you know, legitimate efforts that Hershey is, is taking seriously that just so happened to be good for PR and, and marketing purposes.

[00:19:12] Shawn O’Malley: You know, and, and whether that’s from renovating schools to building roads, Hershey’s is definitely putting real money to work revitalizing the communities it relies on. And as I said, there are good economic reasons to do that. Another angle though, on all this cocoa supply talk relates to China. Chinese consumers as the country has become wealthier and people have more money to spend increasingly discovering chocolate and shocker, yes, they really like it and now they can increasingly afford it too.

[00:19:41] Shawn O’Malley: As I said, and as with many other commodities coming from Africa, China has gotten involved directly by loaning funds to help build things like processing plants and storage warehouses. Presumably with the goal of pivoting African suppliers away from western companies, eventually to Chinese ones and African cocoa producers naturally want a larger slice of the profit pie.

[00:20:02] Shawn O’Malley: While the Chinese government knows that most of its domestic chocolate sales are owned by foreign brands and thus wants to secure control over processed cocoa supplies to sell to Chinese companies. So you can see how African cocoa producers are trying to take advantage of the leverage they have, and the Chinese government is increasingly trying to reshape the global cocoa market to support Chinese companies.

[00:20:25] Shawn O’Malley: And although demand for chocolate is growing, Hershey is unlikely to find success expanding in China. So it’s, it’s really a lose lose for them because they’re probably not gonna be able to sell their product in China. ’cause the Chinese government wants to support Chinese companies and and doesn’t necessarily want these foreign brands like Hershey’s entirely dominating the market.

[00:20:45] Shawn O’Malley: Meanwhile, that just means more competition for the underlying cocoa commodities, which is making supply tighter and contributing to higher prices.

[00:20:55] Daniel Mahncke: And that’s another long-term concern. Right? I mean, we talked about the regional aspect of confectionary companies and usually what you would say, I mean you mentioned the iPhone before, while the iPhone could go into China and sell there too, it’s very hard for Hershey’s to do so.

[00:21:10] Daniel Mahncke: You add competition but you do not really have more market to sell to and that’s never a good thing. And also, I mean, you know me, I’m a skeptic and when you mentioned all the sustainability initiatives that Hershey does, I first thought, well, how much of this is actually PR and whatnot? But I think what matters most is how the incentives are said.

[00:21:32] Daniel Mahncke: And for Hershey, it just makes sense to have these sustainability initiatives and they’re not much of a marketing tool and more kind of like an essential part of the business, especially if we think about the future, not the risks involved for the e cocoa production. And you know, we talked about a lot of the risks now that also send Hershey’s stock press down.

[00:21:52] Daniel Mahncke: And that weakness and the past months also spurred interest from Mondelez, which is another confectionary giant. And it’s best known for the Aria burn, which of course is also a huge thing in in Europe and in Germany. And I do think they approached Hershey for a takeover. Is that right?

[00:22:10] Shawn O’Malley: Yes and it got rejected by Hershey’s controlling shareholder. The structure is weird and there’s an entity known as the Hershey Trust Company that is the controlling shareholder in Hershey, the company we all know. And this trust company has 80% of the voting power, despite only having 20% of the economic interest in the company. And the trust rejected the takeover bid from Mondelez for being too low and rather than countering, it appears that Mondelez is now focused on increasing its share buybacks and dividends and probably making smaller acquisitions.

[00:22:47] Shawn O’Malley: So I don’t expect Hershey to get bought out and, and there’s a few reasons for that, or most of all is because they explicitly declined Mondelez for context. The trust owns pretty much all of the B shares that are outstanding, and that is opposed to the common shares that are the ones traded publicly that you and I could purchase.

[00:23:06] Shawn O’Malley: And because of the differences in voting power between those share classes, the trust has 80% of the vote, right? That’s how you get to it. And funny enough, this isn’t the first time they’ve rejected a bid from Mondelez either. The first rejected bid was actually back in 2016, and they’ve rejected other acquisitions over the years going as far back as an offer from Nestle in 2002.

[00:23:28] Shawn O’Malley: So to just kind of pull the thread here further, ’cause I do think it’s important to understand who is Hershey’s most powerful shareholder. The Hershey Trust Company was set up by the company’s founder, Milton Hershey in 1905. And you know, the aim was pretty noble, right? It was intended to support a handful of charitable causes, whether that be private boarding schools for lower income students to nonprofit botanical gardens and theaters.

[00:23:52] Shawn O’Malley: Milton had hoped too that it would also serve as a local bank for his hometown and be able to provide mortgages and loans and savings accounts for residents. But it has, however, been plagued by a number of scandals over the years from concerns over excessive compensation for board members of the trust to a questionable $12 million purchase of a troubled golf course, and even discrimination allegations about denying admissions to a student with HIV and ports of wire fraud.

[00:24:22] Shawn O’Malley: It’s just a really messy and uninspiring picture for shareholders in the company at large. And despite all those issues with the trusts that I just outlined, I do think Hershey, the company, has a really interesting origin story that maybe I’ll just go on a tangent on here. It’s worth mentioning that despite coming from the same area as Hershey’s Ice Cream, they’re actually not affiliated with each other and they’re completely different companies.

[00:24:47] Shawn O’Malley: And I, I actually really love Hershey’s Ice Cream, and I had no idea they were separate companies. For years. I thought, I, I thought they were the same. So it was a, it was a shock to me. And you know, you can imagine that there were decades of trademark disputes, which there were. So it, it’s not surprising, but the story of the Hershey company though, begins in 1873 with Milton Hershey’s printer ship with a confectioner.

[00:25:10] Shawn O’Malley: And that led him to open a candy shop in 1873 in Philadelphia. And then basically he had three different ventures fail of trying to open shops in Philly and Chicago and New York. And eventually that all led him to return to iconic Lancaster, Pennsylvania, to once again try from a different angle. And rather than running a storefront, his big idea was to found the Lancaster Caramel Company.

[00:25:35] Shawn O’Malley: And from there he built a milk processing plant, where eventually, by 1899, he devised his signature method of producing Hershey milk chocolate. Then in 1900, he sold off the rest of his caramel company for a million dollars and. Chose to focus only on chocolate, which was sort of visionary in a way. He recognized that caramel was just a fad at the time, but he saw chocolate as more of a permanent thing that people would always want to eat, and that’s kind of funny, but he was right.

[00:26:05] Shawn O’Malley: Chocolate is considerably more popular today. The chocolate business took off pretty quickly from there too. And he soon constructed a chocolate plant in his hometown, which made for an affordable place for his workers to live. And then the origins of the famous Hershey Park stem from him trying to improve employee morale by providing them with some leisure activities for workers and family.

[00:26:27] Shawn O’Malley: And then in 1907, Hershey produced the company’s famous Hershey Kisses chocolates for the first time. And to jump a bit ahead in the story, Hershey would round out the other pillar of its business. And in 1963, by merging with Harry Burnett Reese’s Company, who had invented the Reese’s Peanut Butter Cup.

[00:26:45] Shawn O’Malley: And then today, Reese’s represents about 30% of the company’s sale. So obviously that merger has had a lasting impact on what Hershey’s is today. The other aspect of its Candy Empire is Kit Kat, which you might be interested to know, isn’t entirely owned by Hershey. For context, in 1969, Hershey received a license from a UK based company Node as Rone Tree to Manufacture and Market Kit Kat and Rolo in the us.

[00:27:12] Shawn O’Malley: And after Hershey’s competitor Nestle acquired Rone Tree in 1988, it was still required to honor that agreement, and because of that continues to make in market Kit Kat products in the US only. But that license would revert back to Nestle if Hershey were ever sold. So losing the licensing rights to the Kit Kat brand has actually been a major sticking point in the sales offers that Hershey has received, because of course, when a company like Mondelez comes and offers to purchase Hershey.

[00:27:41] Shawn O’Malley: They’re not accounting for Kit Kat in that offer. And then from Hershey’s perspective, because they’re gonna lose Kit Kat operations in the us they don’t see the offer as, as being high enough and being valid. So again, that is part of the reason why I don’t think Hershey will would ever sell. And it’s not entirely because of the trust company, but certainly the trust company is something worth understanding better.

[00:28:01] Daniel Mahncke: So there it was, huh? The, the Kit Kat story I was waiting for, and it’s kind of funny how every time you do not know what product in the food space or what company sells a product in the food space, it seems to be Nestle thought it was interesting when you talked about the Hershey Trust and the 80% voting power they have.

[00:28:20] Daniel Mahncke: I do not have a strong, or I do not have a generally strong opinion on having one large shareholder. I think there are positives and negatives and I think Hershey does a great job of showing both. So, so a positive in my opinion would be that you have a long-term focus instead of falling for, for these theses of Wall Street.

[00:28:38] Daniel Mahncke: And this, this shortsightedness of focusing quarter to quarter and, and that kind of being your worldview, right? And then you have the negatives, as you mentioned as a shareholder, you have very little influence on what happens to the company. And if you have a stubborn owner, like the Hershey Trust seems to be looking at all those offers, they declined.

[00:28:59] Daniel Mahncke: It can be a bit frustrating. For example, the market seemed to like the idea of a merger. I think the stock went up about 10% on the news, but now that that seems to be off the table, what does Hershey’s roadmap for the future look like? I mean, what’s something that shareholders and maybe you can get excited about.

[00:29:19] Shawn O’Malley: With a company as old and mature as Hershey’s? I’m not expecting anything too dramatic, but they do continue to acquire new brands here and there that sort of round out their business. Last November, for example, they acquired sour strips. And they’ve also aimed to increase their production of gummy candies by 50%, which they’ve paired with a partnership with Shaq.

[00:29:44] Shawn O’Malley: They literally call them Shaq Dalicious Excel Gummies. And they’re just really big gummies of Shaq’s face. But it’s one example of how they can use these sorts of promotional partnerships to drive new product lines like gummies, which wasn’t previously a big area of business for Hershey. And at the same time, despite having so much brand power, Hershey’s has been under some competitive pressure.

[00:30:09] Shawn O’Malley: We mentioned already that consumers have shown a good deal of price sensitivity around confectionary treats and folks trading down to lower price. Candy brands and store brands is a real pain point for them coming outta the pandemic. And they also face challenges from up and coming brands too, like Mr.

[00:30:26] Shawn O’Malley: Beast’s chocolate bars. For listeners in the audience who, who don’t know Mr. Beast, he’s basically the most popular YouTuber in the world. And an icon for Gen Z in many ways. And his brand is so big that I’m not sure Hershey’s could ever hope to compete with it, with paid marketing. You know, chocolate is is not his top focus, but his brand is growing really quickly and is continuing to be rolled out across the US and that will only eat away at Hershey’s sales on the margin.

[00:30:56] Shawn O’Malley: So I, I do find that concerning. I also mentioned that North America remains Hershey’s primary focus because it’s so hard to scale confectionary products internationally, right? Hershey’s is sold in 60 countries, but most of those sales outside of North America are rounding errors to the, the broader business.

[00:31:16] Shawn O’Malley: The reality is that people tend to have strong regional biases toward their favorite candies. Something I know, you know, Daniel, and so recreating a Hershey’s success in the US within a different cultural context with existing or new chocolate brands is, is just no simple thing to do. Sees Candy has been one of Warren Buffett’s best investments, teaching him enough about brand power and pricing power to eventually invest in Coca-Cola, which we both know has been one of his biggest winners ever.

[00:31:44] Shawn O’Malley: And even Sees Candy couldn’t overcome the regionalism of the confectionary industry. It’s particularly popular in California and the Western us, but otherwise, it’s not that widely known. Despite all the publicity that Buffet has given it over the years, there’s a lot of nostalgia surrounding the brand and its core markets.

[00:32:03] Shawn O’Malley: But outside of there, these emotional attachments just really don’t translate. One thing that does offer some room for optimism though, is Hershey’s plan to better manage its operating costs, which you know, is something it can directly control and can help offset these upward swings in cocoa prices that we’ve seen.

[00:32:22] Shawn O’Malley: One of the things they’ve done is that they’ve digitized their product portfolio with a new system called S-A-S-P-S four Hannah System. Just kind of a mouthful to say, but it’s a core part of what Hershey’s calls. Its Triple A initiative, which stands for Advancing agility and automation. And basically it’s an enterprise resource planning software that gives them realtime insights into inventory needs.

[00:32:44] Shawn O’Malley: It allows Hershey’s to have a live look at demand on the retail side and supplies of cocoa sugar and all the other ingredients that go into production. And because of that data, it’s expected that there’ll be significantly more accurate and forecasting supply and demand, allowing Hershey’s to minimize waste.

[00:33:02] Shawn O’Malley: And obviously all that’s really valuable from a supply chain perspective and saving costs for Hershey’s. And for example, you can imagine that with Reese’s, they need to know how many they need to make and they also need this system that can help tell them how many tons of peanuts and cocoa to go out and purchase.

[00:33:20] Shawn O’Malley: So the system enables managers to be more proactive about maintaining their production lines. It could help them figure out the best time to even repair and maintain or clean equipment and, and a lot of stuff like that. So it just adds a lot of efficiency in different ways, and management expects it to be fully complete by 2026, which is anticipated to save them about $300 million per year from there.

[00:33:42] Shawn O’Malley: So it, it’s pretty substantial. Who knows if that comes to fruition. I wouldn’t necessarily factor it directly into my analysis, but like I said, it gives me maybe some reason for optimism and shows that even after all these years, Hershey’s is still finding ways to boost efficiency, which can unlock earnings growth.

[00:34:00] Daniel Mahncke: You mentioned so many interesting facts now. One of the things that came to my mind is that it’s interesting how we just said that the legacy brands in the industry have such a strong regional focus. You know, Hershey’s mostly being in the us. Sees candy, even part of the US and then many brands that are in Europe and everything.

[00:34:20] Daniel Mahncke: And it still looks like those personal brands, these influencer brands have far more reach. You know, Mr. Bees is obviously from America, but everyone here knows him too, and I think that’s true for every country. I think he even does his videos now and pretty much every language you could imagine. And for some reason it’s that culture and region does not play a huge role there anymore.

[00:34:42] Daniel Mahncke: So I do consider this long term, not maybe in the now, in the next two or three years, but long term I do consider that a risk for companies like Hershey just because that’s something they never were able to do. And it seems like influencers, also European or German ones, seem to be pretty successful in doing exactly that, but staying in the here and now.

[00:35:04] Daniel Mahncke: So how does the competition look like from the legacy burns and how does Hershey fit into that field?

[00:35:10] Shawn O’Malley: Hershey’s is at the top of the industry together with a few select companies, some of which are also privately owned, so not all publicly traded, and, and those are Mars and Ferrero. And then there are others such as Nestle, MEI, and Mondelez that are public companies.

[00:35:27] Shawn O’Malley: And together they form a small cluster making up the six largest confectionary companies globally with Hershey Ranking fifth, according to revenue. So it’s, it’s not the biggest dog in the race there. And for me, the competition story really mostly surrounds Mars. They’ve been a really tough competitor for decades now.

[00:35:47] Shawn O’Malley: And fun fact, Mars is the reason that Hershey had to create a marketing department back in the 1960s. To counter that competition, Mars makes m and M’s. Skittles, Twix, Pop-Tarts, dove chocolate, Snickers, Cheez-Its Pringles, and also Rice Crispy treats. So a lot of well-known brands there, and I mean, that is one heck of a lineup.

[00:36:11] Shawn O’Malley: But as of 2019, the Hershey company was still by far the leading US chocolate firm with control over 44% of the US confectionary market. And Mars comes in second with roughly 30% market share. Funny enough, though, Hershey actually helped build Mars. In 1923, Mars’s founder turned to Hershey for help with getting the necessary chocolate supplies for its now famous Milky Way bar.

[00:36:40] Shawn O’Malley: And what was once a small regional brand quickly turned into this smashing success, thanks to the Milky Way bar. And suddenly, Mars wasn’t just a pier, but now it was a close competitor. And despite competing with each other, Hershey’s actually continued to supply Mars with chocolate well into the 1930s until Mars kind of upped the ante of the rivalry by vowing to overtake Hershey’s.

[00:37:04] Shawn O’Malley: As the king of chocolate, which are still working to do to this day. And in response to the Milky Way, Hershey unveiled the Mr. Goodbar, which is basically just a Hershey bar with roast peanuts, and then Mars responded with the Christian of the Snickers. So there’s some real innovation here, especially at that time in the world of chocolate candy.

[00:37:23] Shawn O’Malley: And really in hindsight, I, I kind of see Mars as being way more effective at churning out popular new products. I’ve certainly had way more Milky Way bars than I’ve had Mr. Good Bars in my life. And one of the other really compelling products they created was m and ms. And at a time that was pretty innovative for the protective shell that those candies had.

[00:37:44] Shawn O’Malley: It made it more resistant to melting, which is the biggest problem for any chocolate candy based treats. And more recently though, Hershey’s has unveiled products like the Reese’s Caramel Big Cup. And that actually ranked as the number one new candy innovation in 2023. So at least recently, Hershey’s has been a bit more aggressive about launching new types of products.

[00:38:05] Daniel Mahncke: You mentioned that Mars does a pretty good job both marketing wise and also putting out new products. And I must, if I think back, I must admit I also know a lot more Mars products than I know Hershey wants. You just said it and it was fascinating to hear that the m and ms are actually resistant to melting because of their protective shell.

[00:38:22] Daniel Mahncke: I never thought about that. I didn’t think that innovation is actually something that we see in the candy space too, but I guess it says a lot more about my knowledge about the candy space than anything else. I thought it would just be, just be about the taste. But getting back to the operational side, because that’s something I think we should talk about, and that’s that Hershey’s, CEO, Michelle Buck actually announced that she will retire in June, 2026.

[00:38:47] Daniel Mahncke: And the stock reacted with a two to 3% decline. And I still remember when I looked at Nike that Nike stock actually had a 10% rally the week that Nike, CEO, John Donahoe was let go of, let’s say like that. And I was seeing that the stock declined after the announcement of Michelle Buck retiring. It does seem like she was a popular figure in the company.

[00:39:13] Daniel Mahncke: Do you think it will be a problem looking for a successor that’s as capable or who’s as capable as she was?

[00:39:21] Shawn O’Malley: It’s always a big deal when you’re changing leadership at the top, right? And and yeah, it was announced that Michelle Buck will be stepping down in 2026 after having led the company since 2017.

[00:39:32] Shawn O’Malley: So for all the headwinds and challenges facing Hershey that we’ve already discussed, as if there weren’t enough, now you layer in succession planning in, in these leadership changes. And again. It’s just no surprise to me on why the market has, has mostly soured on the stock over the last two years. But at 63 it’s also not unprecedented to wanna retire.

[00:39:53] Shawn O’Malley: And fortunately there is a long lead time ahead for them to kind of figure out a plan. There’s a, apparently a special committee that is leading the search and they’re considering both internal and external candidates. I’d presume while she has helped lead the diversification efforts into salty snacks like dots, pretzels, and skinny pop popcorn, SES is still not as diversified as its peers, so there is a lot of room for improvement here.

[00:40:20] Shawn O’Malley: Nestle, for example, has products that range from dairy to coffee. And I think you said earlier, you know, anytime you go to a store and, and you don’t know what company has produced a product, it’s a good chance. It’s, it’s Nestle and even Mars as we talked about for all their innovation in Candy. Now they have pet food brands, which, you know, maybe is like not a good or bad thing, but.

[00:40:41] Shawn O’Malley: The point being a lot of these companies have seen the writing on the wall and have, have significantly diversified, and Hershey’s stands out for falling short of doing so completely. But I did find this quote in a Bloomberg article from a former higher up at Hershey who remained anonymous talking about Michelle Buck and, and he said basically that quote, Michelle knows that business inside out and backwards, it’s gonna be hard to replace her.

[00:41:06] Shawn O’Malley: And so, you know, that makes a lot of sense then that the stock sold off 2.5% immediately after it was reported she’d be leaving. And I’m sure it’s contributed to the continued weakness in Hershey’s stock over the following months since that report came out. And this comes after the executive that Hershey’s handpicked to lead its US Candy Division also quit just three months into the job after having been with Pepsi for 23 years.

[00:41:32] Shawn O’Malley: And again, I think that’s just showing how tough of a business Hershey is to run. Right now. You have a lot of these longtime industry veterans. Bailing on the confectionary market, and we haven’t even talked about the new presidential administration and how RFK Junior who’s been tapped to be the country’s top health official, has basically vowed to directly take on companies like Hershey for their responsibility in widespread health problems like diabetes and childhood obesity.

[00:42:02] Shawn O’Malley: So from lawsuits to regulations forcing them to change their formulas and supply chains to simply bad press. The risks from government and public scrutiny are also mounting here for Hershey to say nothing of tariffs either, which is a really big elephant in the room. Hershey’s is, in some ways, arguably as beloved as any brand like Disney or Apple, especially around the holiday season, but it just feels like the business cannot catch a break right now, and that is making the markets increasingly paranoid about its prospects, which if taken to an excess, can actually create attractive buying opportunities.

[00:42:38] Shawn O’Malley: Some investors have certainly recognized that as the stock just in the past few weeks has mounted a bit of recovery after their Q4 earnings.

[00:42:45] Daniel Mahncke: I have to add to the management discussion that I usually do not pay too much attention to management if the company’s as big as Hershey’s. However, if someone leaves after just a couple of months, and he’s known for usually saying decades at different companies, it does seem a bit odd to me.

[00:43:04] Daniel Mahncke: But now maybe kind of initiating a new topic. There’s a quote of Buffet coming to my mind as so often the case, I mean, part of my internal monologue is just buffet quote, no, obviously I’m kidding, but I still want to phrase it out and then ask you what you think about it. So the quote is, the single most important decision in evaluating a business is pricing power.

[00:43:25] Daniel Mahncke: If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the prize by 10%. Then you’ve got a terrible business. So you mentioned Apple and Disney, two companies with immense brand and pricing power. How would you say does Hershey fit into that picture?

[00:43:50] Shawn O’Malley: So as an investor, that is clearly the big question. Yeah, I can’t know what will happen with cocoa prices, if I had to guess. The outlook here has a good bit of fear and worst case scenarios already baked in. Meaning the range of outcomes actually probably skews toward the market at some point.

[00:44:06] Shawn O’Malley: Being relieved that cocoa supply doesn’t remain as tight as feared for as long as currently feared. I guess another way to say that is we can probably look past the rise in cocoa prices, not ’cause they won’t continue to be high, but because at some point that will just be a part of their business structure and won’t be negatively impacting profits relative to previous years.

[00:44:29] Shawn O’Malley: I tend to think that if prices are high enough, though, we will always find new ways to produce something or unlock supplies that were previously unavailable, and I’m sure the same is true with cocoa. Maybe I’m naive, but without being an expert on cocoa supply chains, high enough prices should eventually induce more farmer to plant cocoa trees.

[00:44:49] Shawn O’Malley: But I’m kind of sidestepping the question because the bigger question here is, does Hershey’s have pricing power? And if Hershey’s doesn’t have pricing power over its customers, then that’s a much bigger issue for shareholders long term, because whether it’s cocoa or sugar or tariffs or taxes, whatever it is, there are a lot of different angles that costs can be imposed on this company.

[00:45:12] Shawn O’Malley: And if Hershey’s cannot adequately pass it on to consumers, that’s a big problem for shareholders. Again, it’s one thing for cocoa prices to rise, but if Hershey’s prices rise correspondingly, then there shouldn’t really be any impact on margins, at least in theory. The business would basically just be as profitable as before.

[00:45:32] Shawn O’Malley: And in that case, it wouldn’t really matter if cocoa prices swing from year to year, but that’s contingent on them being able to raise prices in line with the increases in input costs. And in other words, I guess you could say, if Hershey could adjust prices as needed, they could keep their business intact.

[00:45:48] Shawn O’Malley: Assuming there’s no sensitivity from customers and economics, though you might say that demand for Hershey’s products resembles what you might call elastic demand, meaning that customers are sensitive to pricing and will purchase fewer items. If prices jump too much, you’re not going to pay any price for a chocolate bar.

[00:46:08] Shawn O’Malley: There are limits to what consumers will expect, whereas, you know, gasoline is the classic example of an inelastic. Good demand is not that sensitive to prices. And for anyone in the audience who doesn’t believe me, consider the price you’d be willing to pay to fill up your car with gas if you ran out on the highway.

[00:46:28] Shawn O’Malley: People see cars as an essential part of their life, and correspondingly gases too. So if you ran outta gas on a road trip and the only gas station nearby was $30 a gallon, I would still pay it, you know, at least for one gallon, because you know what other option is there until you can find another gas station.

[00:46:45] Shawn O’Malley: And so to bring it back to Hershey, we know that structurally people aren’t going to be as insensitive to chocolate prices as they are with gas. It’s, it’s just the reality. But we also know that people really love chocolate, so they might be able to absorb some amount of higher prices and, and maybe more than you’d think.

[00:47:01] Shawn O’Malley: I know I, I’ve definitely splurged on some chocolate bars that might have cost me five or $6 for a few ounces of chocolate. But when you’re craving chocolate, that price maybe doesn’t seem that steep in the moment. I’ve certainly regretted it after, but you know, when I’m ch chowing down on a Hershey bar and, and kind of enjoy that moment of bliss, $5 doesn’t seem that crazy.

[00:47:20] Shawn O’Malley: And then this gets into, you know, a whole nother conversation about how Hershey’s is priced relative to its competition. And that’s what I think really is at the core of its pricing power discussion. If every chocolate product in the world raised prices exactly in line with increases in their cost for cocoa and did so at the same time, Hershey’s would probably see no drop off in sales volumes.

[00:47:42] Shawn O’Malley: But obviously that is not what happens. Every chocolate brand does their own assessment of how their economics work out. They hedge their costs differently and they decide then how much of an increase in input costs they can absorb versus how much they can and want to pass on to consumers. So Hershey’s is not raising prices in a vacuum that, that’s my biggest takeaway.

[00:48:04] Shawn O’Malley: If they raise prices by 10%, while private label brands only raise prices by 5%, then Hershey’s has become relatively more expensive compared to the other options. And when we ask whether Hershey’s has pricing power, this is, you know, really what we’re talking about. If Hershey’s has a degree of efficiency or hedging expertise that can help them hold off on price hikes for longer than oth than other brands.

[00:48:26] Shawn O’Malley: That’s one thing and sort of a separate discussion, but can Hershey’s raise prices in excess of discount brands or if they become relatively more expensive? Is brand loyalty strong enough to prevent people from trading down to cheaper confectionary alternatives? Hershey has seen some minor declines in volume during periods of aggressive price hikes like late 2022, but these have been offset by revenue growth due to that higher pricing, and Hershey has generally maintained an average price premium of about five to 10% for its core products over competitors in North America.

[00:49:04] Shawn O’Malley: Reflecting that it is something of a premium product, you might say, and one that goes from being discretionary for most of the year, but arguably becomes non-discretionary. Around Halloween and Christmas. Products like Kit Kat and Reese’s are stable parts of what people expect to consume or pass out on Halloween.

[00:49:21] Shawn O’Malley: Which is why I say their branding power magnifies to an extent during these times. That makes ’em almost an essential good to some customers, rather than just purely being an impulse purchase in checkout lines, which is kind of what they are for most of the rest of the year, and maybe you say the same about Valentine’s Day.

[00:49:37] Shawn O’Malley: And on top of that, they’ve also historically engaged in what’s known as Tril, where Hershey reduces product sizes such as reducing the size of Reese’s peanut butter cups or the number of kisses sold in a bag. And that’s sort of an alternative way to implicitly raise prices. There’s a lot of nuance here at the product level, of course, and each product.

[00:49:57] Shawn O’Malley: Almost has its own pricing, power and positioning in a way, right? Some products you can raise prices for more easily than others. For example, Snickers is often priced slightly less than Hershey’s Bars, but Hershey’s has the ability to upsell through premium seasonal offerings like holiday themed chocolate bars with peppermint, and that gives them these kind of temporary, but also recurring annual boosts to the company’s market share and profit margins.

[00:50:22] Shawn O’Malley: And then in response to a wave of public health concerns about sugar that we, we’ve kind of alluded to already. Hershey’s did lean into sugar free chocolates with a brand called Lilies, which has its own unique perceptions amongst customers, but typically is priced at a 15 to 20% premium relative to regular Hershey’s chocolate.

[00:50:42] Shawn O’Malley: So I think I’m kind of sidestepping the question on pricing power. In short, Hershey definitely has some pricing power given how famous their brands are. That fame comes with some nostalgia and many, many years of marketing eating away at people’s subconscious perceptions, and that all combines together to make it likelier that Hershey can raise prices without a proportionate decline in sales volumes.

[00:51:07] Shawn O’Malley: From a 30,000 foot view, I think this is something that they mostly could do, either with price increases or FL going forward. And when equity research analysts bashed the stock for absorbing higher costs, over the last year at least, this has really only translated to a one to 2% decline in operating profits.

[00:51:25] Shawn O’Malley: So we’re not talking about being completely unable to raise prices and massively damage by higher commodity prices.

[00:51:34] Daniel Mahncke: I think you’ve given a pretty good picture now on brand power and also pricing power, and I do know that you like to look at what Buffer does, and you already mentioned it today. That he bought Seas candy.

[00:51:46] Daniel Mahncke: Right. And that’s kind of his investment or the investment that made him go more into the direction of buying better brands and buying those brands that have pricing power. Now probably. And you also mentioned that one, Coca-Cola is the investment that most people would connect to Buffer in that way, maybe even after 2016, apple.

[00:52:06] Daniel Mahncke: That might be. But I know that you probably also picked Hershey because you see those parallels to see Candy and what it did for Buffet. So once again, maybe how do you think Hershey fits into this and just hypothetically, we Buffet and Mango currently buy Hershey or at least like it for the business it is.

[00:52:25] Shawn O’Malley: I appreciate you bringing up Buffet and Munger because I’m always looking for a chance to pull a thread, just say a little further to to have an excuse to talk about Charlie Munger and poor Charlie’s Almanac, which is this wonderful compilation of Charlie’s thoughts over the years. There’s a transcript from a speech titled Practical Thought About Practical Thought, and he muses about this hypothetical scenario of creating a $2 trillion company from a $2 million investment over 150 years.

[00:52:56] Shawn O’Malley: And basically what you would have to do to accomplish that. And even though it’s about Coca-Cola, I think the same applies to Hershey’s. And what he was ultimately describing is a phenomenon called the Lollapalooza Effect, which is a combination of multiple psychological factors that combine together to distort our decision making.

[00:53:18] Shawn O’Malley: So with Coke, you have a unique name that makes the product stand out. There’s caffeine, which is one of the most addictive substances in the world, as well as sugar, which you could say the same for, and a whole bunch of marketing to condition people, to associate Coke with fun times or beautiful women, and then standardized global production so that no matter where you are, the experience is consistent.

[00:53:40] Shawn O’Malley: When drinking a Coca-Cola and when you’re traveling across some foreign land and stopping to a store for a drink, all of those factors will implicitly bias you to pick Coke over anything else. You recognize the brand, you’ve been conditioned to associate it with positive feelings. You crave what’s in it, and importantly, you know what to expect, which remove a huge barrier to purchase.

[00:54:04] Shawn O’Malley: One of the hardest things about sales is convincing people why they should care about your product, and not having to do that to the same extent is really the advantage of Coke. Like I said, if you’re in some strange new place and you’re thirsty and you just wanna drink, you’re gonna go with what’s familiar.

[00:54:19] Shawn O’Malley: At least I would, right? Personally, you’ve, you’ve never heard of the local Cola brands and you have no idea if they’re any good or what they’ll taste like, but you know exactly what Coke is gonna give you. And the same is true for McDonald’s and any other global brand. And that’s why I think the brand power behind Hershey’s assets are so powerful in, in some ways.

[00:54:36] Shawn O’Malley: Charlie Munger could have just as easily been describing Hershey’s in his talk, which I’d really encourage anyone to check out. Hershey’s has sugar, caffeine, and also chocolate, which has its own unique addictive properties. And combined with its consistent taste and brand recognition, that all goes into the Lollapalooza effect subconsciously driving you to impulsively grab a Reese’s or a Hershey’s bar.

[00:54:57] Shawn O’Malley: And I can’t say why Buffet and Munger never invested in, in Hershey’s over the years to some extent. You just can’t invest in everything. And I’m not sure, maybe they see some flaw in the business that, that I don’t see. But at least at a, you know, from a, from a high level view, a lot of the wonderful things that have gone into building a brand as powerful as Coca-Cola, you could say the same for, for Hershey’s.

[00:55:22] Daniel Mahncke: You and I both know that both Charlie and Buffet, they’re huge opportunity costs. So it’s very well possible that they just had better opportunities available whenever Hershey came up on their mind. Now let us get back, because I think we covered quite a lot of qualitative facts. Now, maybe let us get back to the financials for a moment.

[00:55:41] Daniel Mahncke: We already mentioned that the last quarter was actually pretty good, a lot more stable than people would’ve expected. Let’s say it’s increased 8.7% year over year. That didn’t income more than doubled, and the profit margin was over 30%. So all of that is a lot better than I would’ve initially thought. Now we also mentioned that it’s currently trading at 17 times earnings, which is pretty reasonable and seems like a good valuation.

[00:56:07] Daniel Mahncke: But the question is, will they be able to keep this performance up? And also the valuation that comes with how will earnings drop so significantly that the valuation you have to pay now is actually not that attractive? So what’s your take on that? And maybe on the quarter in general.

[00:56:23] Shawn O’Malley: The stock did pop after earnings, so the market clearly liked what it heard. And by the time people listen to this episode, the stock may not be as cheap as when we first recorded it. I think it’s always funny though, to listen to earnings calls because the analysts can have their heads so deep in the weeds. It’s like, it’s very frustrating. They’re worried about whether costs of goods sold is gonna come in 0.5% higher next quarter or something like that.

[00:56:48] Shawn O’Malley: And it’s just frustrating because they don’t really ask a lot of the big picture qualitative questions that at least as a long-term investor, I’m kind of keen to, to better understand. So there it is. That’s my rant on equity research analysts. But for all the feared weakness in Hershey’s business Sales Rose almost 9% year over year.

[00:57:09] Shawn O’Malley: The Shack gummies were a big hit and were one of the fastest growing sweets brands last quarter. And Jolly Ranchers were really strong thanks to their new Jolly Ranchers ropes product, which I didn’t even know about, but I’m kind of excited to try at some point. And you know, whether it’s from Mint and Gum sales to Hershey’s Brookside brand that sells blueberries covered in dark chocolate, everything looked pretty solid from what I could tell.

[00:57:34] Shawn O’Malley: And I think there’s some excitement because Michelle Buck teased that the company will be unveiling their biggest Reese’s Innovation ever while having their fingerprints all over the Super Bowl, which they did, you know, from ads about Reese’s Lava Big Cup to partnerships with Barill Sports and Jason and Travis Kelsey’s podcast, which is one of the biggest in the world right now.

[00:57:54] Shawn O’Malley: Probably not a coincidence that Travis Kelsey is dating Taylor Swift and you know, then on the salty snack front. Again, everything just looks really strong. Skinny Pop had better sales than expected and continued to gain market share in the ready to eat popcorn category, and they teased some new dots, pretzels, flavors, to expand the brand’s market share.

[00:58:14] Shawn O’Malley: Though Dots is already the second largest pretzel brand, so it’s worth mentioning that Hershey’s business doesn’t entirely revolve around chocolate or even sweets. And despite all the concern about cocoa prices, other parts of the business continue to keep chugging along. It was interesting to me that when talking about cocoa prices being very volatile, Hershey’s, CEO focused on the fact that cocoa trading isn’t a very liquid market as opposed to having issues with the underlying supply.

[00:58:42] Shawn O’Malley: Right? I’ve heard that because cocoa has gotten so expensive, traders have to put down a lot more capital upfront to make bets on futures contracts, and that extra capital or extra collateral needed to reduce leverage has driven a lot of volume out of the market. It was almost as if she was implying that the issue with cocoa price volatility at least more recently isn’t because of supply, but it’s actually ’cause of illiquidity in cocoa financial markets.

[00:59:11] Shawn O’Malley: Maybe I’m reading into it too much, but nevertheless, I, I found that really interesting and she actually says explicitly that they don’t believe current high prices are reflective of market fundamentals. So I think that factored into the big relief that markets have felt about Hershey after it reported earnings.

[00:59:28] Shawn O’Malley: Hershey’s has apparently secured their cocoa needs for the year and have seen cocoa supplies in the Ivory Coast and Ghana both rise 30% since last year. So that all suggests that the worst is behind us and that’s, you know, markets love nothing more than hearing those kind of statements. But because of the hedging dynamics we discussed earlier, they do feel the effects that’ll lag So higher cocoa prices will really first show up in 2025 and are gonna hurt earnings.

[00:59:58] Shawn O’Malley: Gross profits are supposed to decline by as much as seven percentage points, and that ripples down through the rest of the income statement to reduce earnings too, of course. And the gross margin pain there isn’t just from high cocoa prices, but also from higher sugar prices, higher labor costs and tariffs.

[01:00:14] Shawn O’Malley: So improvements in the cocoa market aren’t going to fix all of their problems with input costs. I did dig into some equity research reports to see what Wall Street thinks of the company and Morningstar’s. David Swartz does have some pretty good coverage of Hershey. I thought his fair value target is $210 per share after the company’s latest earnings report.

[01:00:35] Shawn O’Malley: And I just wanna read some of the comments that he has in it. He says, the lasting rise in cocoa prices has been an Achilles heel for confectionary manufacturers, including Hershey, but we surmise the firm is employing a vast arsenal to blunt the hit. It is removing costs and raising prices while supporting its leading brand mix.

[01:00:57] Shawn O’Malley: And we don’t surmise. Hershey is banking on falling costs. Rather, management exuded confidence in growing earnings in fiscal 2026, absent a retraction in cocoa prices. And then he adds in the report quote, we think concerns around inflation, consumers hunger for health and wellness, and the macro backdrop have weighed on shares.

[01:01:18] Shawn O’Malley: However, we posit the firm is taking a prudent approach, anchored and extracting costs to fuel investments behind consumer valued innovation between Hershey’s dominant position versus private labels. And the resilience of the category as confectionary remains an affordable indulgence. We forecast three to 4% sales growth, so no shortage of Wall Street jargon there.

[01:01:40] Shawn O’Malley: But the sentiment is, and I agree with it, that Hershey remains focused on building its brand long term while controlling what it can control in the short term. And even though earnings will probably fall off this year, there’s good reason to think the company can bounce back in 2026. Thanks to more favorable cocoa prices and its initiatives to bring down operating costs while the company is valued at about 17 times earnings based on last year’s results because of the expected fall off in profits in 2025, its valuation is actually more expensive going forward, looking out over the next year, and it comes up to around 19 times expected earnings.

[01:02:17] Shawn O’Malley: It’s kind of similar with Ulta for anyone who remembers that episode from a few weeks back, and it’s a company in our intrinsic value portfolio where you have this really, really strong brand with a lot of advantages that has just had a weak year, and the sock has been punished because of that. But much of those are short-term pains that don’t necessarily indicate structural problems for long-term shareholders, at least in Ulta’s case.

[01:02:41] Shawn O’Malley: One of the other bear cases though, that I found interesting about Hershey is that 31% of its employees operate under collective bargaining agreements. So in other words, they’re basically unionized. That can create real risks of employee costs. Inflation too. On the other hand, that creates more incentive for them to automate as many roles as possible to cut costs.

[01:03:00] Shawn O’Malley: And we’ve already seen some progress there where I think a few thousand jobs have been trimmed because Hershey has found ways to automate them, which, you know, at a human level is not a great thing, but from an investor’s perspective is a good thing. And and given the strength of Hershey’s brands and their wide brand recognition, especially in the US and 36% market share over the chocolate aisle in North America, which has only been growing since 2015, it doesn’t surprise me at all that Morningstar classifies the company as a wide moat business.

[01:03:30] Shawn O’Malley: And I’d probably have to agree with them. One implicit way that this brand power sort of manifests is the reality that retailers would rather stick with stocking leading brands that are able to drive traffic into their stores rather than devote their precious shelf space to unproven suppliers who may not have the supply chains to provide inventory to their stores nationwide.

[01:03:51] Shawn O’Malley: And the amount of earned media and sponsorships that would be needed to recreate the brand power of Hershey’s or Reese’s is just massive. And that’s why honestly, only Mr. Beast’s chocolate products scare me here because he’s the only one with a following large enough to build a brand that might even remotely rival Hershey.

[01:04:10] Shawn O’Malley: And other analysts have been less optimistic about Hershey, which is worth mentioning. Michael Lavery from Piper Sandler has been cutting his price targets for Hershey to $123 per share. But that is what makes a market, as they say, everybody has differing views.

[01:04:25] Daniel Mahncke: Just looking at the analysts and their estimates, show us how hard it will be for you in a couple of minutes to value Hershey.

[01:04:32] Daniel Mahncke: And it kind of reminds me, although they are not similar on a company level, but it kind of reminds me of last week and Nintendo, where I feel like there’s just a lot of uncertainty and it kind of feels like for Nintendo that might be more to the upside. For Hershey, you have to defend against the bear thesis.

[01:04:50] Daniel Mahncke: I think you did quite a good job about that and not because you were bias in any way, but I think because there are pretty good arguments to say that maybe the bears have taken over and the so was beaten down too badly. But before we get to the variation part, there’s one more thing that I wanna talk about and that’s, and we kind of got to it, is the original character of Hershey’s and the entire industry and the fact that they still had international segment and was growing quite fast, I think there was double digit growth for most of the time in the last couple of years.

[01:05:22] Daniel Mahncke: Now, the last year was a bit more tough, especially for what happened in Europe and kind of around the world. The Russia, Ukraine war. And if I’m not mistaken, I think they do wanna stop investing more into the international business and kind of focus more on acquisitions in domestic burns. Do you have any knowledge of any acquisitions coming up?

[01:05:44] Daniel Mahncke: Or maybe I’m mistaken and they, you know, want to go about the international investments anyway.

[01:05:50] Shawn O’Malley: Your guess is gonna be as good as mine here. What I do know is that Hershey’s loves to buy brands they’ve done with dots and lilies, and they really like to buy companies that specifically have about a hundred million dollars of sales strong margins and which could maybe benefit from Hershey’s distribution and relationships with retailers and its large marketing budget.

[01:06:11] Shawn O’Malley: So the wonderful thing about Hershey’s Playbook there is that they’re disciplined enough to mostly only bet on proven brands, yet they have enough advantage from their scale that they can further level up these still smaller brands and meaningfully grow their business by acquiring them. So if a brand has one value on its own, it almost instantly becomes more valuable when incorporated into Hershey’s portfolio because Hershey has the best relationships in the industry and the deepest pockets, and a proven commitment to wanting to invest large sumps into building these brands further.

[01:06:45] Shawn O’Malley: And of course, there’s a litany of brands they could diversify into. My guess is that they’ll continue to try and diversify into salty products or sugar free confectionary products in particular. But we’ll see for them to grow their salty snacks division from $1 billion in revenue to $3 billion in the next few years, which is what management has said is their goal, that’s gonna take a lot of organic growth and also acquired growth to achieve.

[01:07:11] Shawn O’Malley: They definitely have the cash to keep making acquisitions with, and that can honestly be better sometimes than trying to build new brands from scratch. But because the. Trust that controls Hershey is so very conservative and the fact that they try to pay out at least 50% of their earnings as dividends, that does limit the size of the acquisitions they can do.

[01:07:30] Shawn O’Malley: So I don’t expect anything major, but I’m sure they’ll keep making them on the margins. They’ve said they want to be the number one consumer packaged goods company in the us So with that kind of ambition, they’re definitely going to need to keep snapping up valuable brands.

[01:07:44] Daniel Mahncke: That’s true. To summarize, it sounds like we just have to, you know, wait and see now I pitched it just a minute ago and now it’s your turn to kind of fit all of this into a valuation and I mean, we have to do it.

[01:07:57] Daniel Mahncke: I know it’s a difficult task, but we, both of us, we sit here and all the companies we discuss, we want to come up with an intrinsic value for them. So now the stage is yours and you will show us what you came up with.

[01:08:10] Shawn O’Malley: Let’s do it. I’ll be the first to say that the company’s Q4 2024 earnings, gimme a little bit more room to be optimistic than I otherwise would have been.

[01:08:19] Shawn O’Malley: Because before that, it looked to me like sales were set to keep weakening while margins would be really badly pinched by higher input costs. So don’t get me wrong, some of that is still expected to happen, but it’s probably not as bad as I first feared when I took a look at Hershey a few months ago.

[01:08:37] Shawn O’Malley: And given how the stock has mostly collapsed over the last 18 months, I would still be inclined to be extra conservative to ensure that we’re not trying to catch a falling knife. To use that cliche, you’re never gonna be able to time the bottom with a stock, but you also wanna make sure that you’re not signing up for years of pain either.

[01:08:55] Shawn O’Malley: And on that note, with Hershey’s management forecasting, the gross profit margins will decline a whopping seven percentage points while also net income falls off by something like 40% this year. There’s still pain left to be felt here, and I don’t really trust kind of the the bounce back that the stock has had since reporting Q4 earnings.

[01:09:17] Shawn O’Malley: Those realities are mostly priced into the stock. I’d imagine maybe less so after the recent rally, but it’s still a rough situation to enter into. And to be honest, I have a lot of trouble justifying the current stock price In my model. I try to discount the cash flows over the next five years with some fairly optimistic assumptions around gross profits and operating margins.

[01:09:38] Shawn O’Malley: Normalizing after what we all know will be a bad 2025 and with some modest revenue growth. And I still got a share price target at least as a fair value of $131 per share. And when I tried valuing the company based off of a range of plausible price to earnings ratios by 2029, which is another approach I I often like to do with companies, I got a weighted value of $129 per share.

[01:10:01] Shawn O’Malley: And so the average of the two, maybe too conveniently comes out to a perfect $130 right between the two, and that is a decent discount to the already beaten down stock price at the time of recording. Especially after it’s rallied a bit and to build in a bit of a margin of safety to hedge against things going worse than expected, or that my analysis is off, I couldn’t even really imagine touching the stock.

[01:10:27] Shawn O’Malley: I’d be really, really excited about it given the opportunity costs, unless it were at $115 per share or less, which is, is maybe laughably cheap to some people. But the, the reality is we’re not obligated to buy any company. And to me, a significant decline is needed before I find Hershey’s to be really attractive, which is kind of ironic that I’m pitching it, but it’s always good to at least understand these companies so that in the next big sell off, we’re ready to act on it.

[01:10:54] Shawn O’Malley: And that could easily happen and people may be shocked because not that long ago, the market valued the stock at $275 per share. So, you know, that’s a pretty huge gap between what I see as as an intrinsic value target. Especially because Hershey has such great brands and, and all that stuff. But the reality is that this company’s earnings are expected to nearly get cut in half this year, and things would have to reverse dramatically and quickly in the next few years for the stock to support the kinds of valuations where you could really argue that it’s worth more than $200 per share.

[01:11:28] Shawn O’Malley: Otherwise, in my opinion, at least, the company needs to be revalued at this new normal, where the high gross profit margins of the last decade can’t be taken for granted, given the volatility we know can happen in cocoa prices and just the general inflation environment, you know, from tariffs to unionized workers demanding higher salaries to offset the rampant post pandemic inflation.

[01:11:52] Shawn O’Malley: You get these feedback loops that play on each other where the price of everything’s going up and then workers wanna get paid more, and then that it, it just, it’s a destructive flywheel working against Hershey in some ways. So there’s some real structural challenges that make Hershey fundamentally less profitable than even just two or three years ago, and especially prior to the pandemic.

[01:12:14] Shawn O’Malley: And it feels like I’m being harsh on Hershey, but I just couldn’t find a way to play with the numbers. Honestly, that didn’t suggest its stock was still overvalued. So my fair value for Hershey is $130 per share. And like I said, if it dips below one 15, I might revisit it and suggest it for the portfolio more seriously.

[01:12:33] Shawn O’Malley: And at that point, I’d have to account though, for whatever news drove the stock to those new lows, which could change the picture. And as long as it’s nothing long term, like I said, I could be tempted to reconsider it, but I don’t really feel compelled to own it either at these levels. So I’ve dump a ton of info on you, Daniel.

[01:12:51] Shawn O’Malley: So why don’t you tell me what you think. Is there anything I’m missing here or any reason we should consider for the intrinsic value portfolio?

[01:12:56] Daniel Mahncke: Well first of all, if there’s one thing that I learned in investing, it’s that preparation is everything. I think the more we look at companies and the more companies we have on our watch list, the easier it will be to find the best investments.

[01:13:10] Daniel Mahncke: And I think today’s pitch is one that goes into that direction. Think Kishi is a very good business that might not be as attractive at today’s prices, but it’s definitely one to have on the watch list. And you know, I told you why I love deep dives. And today is an example for why. Because you just learn so much about the business and so much about an industry and the dynamics, you know, that you usually just wouldn’t know about.

[01:13:34] Daniel Mahncke: You know the products when they’re in the store and you see them. And maybe next time I eat a Kit Kat, I’ll think about the production of of chocolate. But that’s kind of just why I love these deep dives. So getting to the valuation, I agree with you that personally I wouldn’t think that this stock is an attractive investment if we are not a lot closer to maybe $115, maybe even a little below that.

[01:13:58] Daniel Mahncke: Personally, and from my experience, I do not like to buy companies where I feel like the surprises that could come in the future are more to the downside. And you made a great case for the cocoa situation, and to me, it just seems like there are a lot more negative surprises that could come to Hershey stock and their shareholders than positive ones.

[01:14:21] Daniel Mahncke: I kind of feel like there’s the potential for a relief rally, kind of as we’ve seen in the last couple of months and weeks, but over long term. And that’s kind of what we’re building this portfolio for. We wanna find companies that we could hold for years. I just see too many risks that for me personally, make Hershey.

[01:14:39] Daniel Mahncke: An investment that I wouldn’t feel comfortable owning with. You know, there’s also the, the factor that I try to avoid companies whenever possible, that I personally do not consume products of. And I give my best to eat as little candy as possible. I mean, sure if I go for candy, it is chocolate as I mentioned.

[01:15:00] Daniel Mahncke: But I just generally do not feel good investing in companies that are not aligned with my values. And maybe for some people who, who do know me from my, my research before. I know that I also talked about companies like evolution. I’m fully aware there’s some inconsistency here, but maybe it just shows that the Hershey case is not, is not getting to my investor heart. Right. So that’s why I totally agree with you.

[01:15:24] Shawn O’Malley: Alright, so there you have it. Our thoughts on Hershey. It was a pretty fun company to dive into and I feel like I came out a little smarter on understanding brand power, even if Hershey’s isn’t itself a screaming by and. You know, the wonderful thing about this show is I can kind of pitch a company, we can talk through it, and as we work through it, if we realize it doesn’t deserve a spot in the portfolio, it wasn’t all lost.

[01:15:48] Shawn O’Malley: I have to admit though, that I didn’t get as excited about Hershey as I normally do when researching companies. And to me that was just a signal, kinda like what you said, Daniel, that the company just doesn’t align with my values, and that’s probably a really poor way to invest, but we all only get to go through this life once, and we have to live with the decisions we make and, and not to like, you know, sit on my high horse here, but I just, I don’t feel great about being someone who owns a company that I know is significantly contributing to obesity and poor health globally.

[01:16:21] Shawn O’Malley: And there’s more than enough companies out there to invest in where I, I don’t have to, to kind of have that thought lurking in the back of my head. To be fair, candy isn’t evil, nor do I think Hershey is evil. Right. It’s just a, it’s just a group of people running a business. Everyone deserves a sweet treat every now and then, and they do a lot of wonderful things to support sustainable cocoa production.

[01:16:44] Shawn O’Malley: And the Hershey Trust does run some honorable nonprofits. Still, I’d be far more inclined to invest in Vital Farms, which is a company I covered a few weeks ago, just because they align much more closely with my personal values. And I think it’s a great business. I, I really do not like to bring personal values into investing too much, so I’ll try not to do that going forward, because what feels good doesn’t always make the most money.

[01:17:08] Shawn O’Malley: But in this case, the externalities produced by Hershey are actually plausible reasons to be bearish on the stock. They could be more closely regulated, fined, and sued for their contributions to America’s health issues and the world’s health issues. And the rise of GLP one weight loss drugs, as in many ways a result of companies like Hershey’s not be more closely regulated in the past from how they can market their products to the type of ingredients they use.

[01:17:33] Shawn O’Malley: So I kind of hate to end the episode on a sour note, but I refrain from sharing my personal thoughts on Hershey’s until we had made a portfolio decision and I tried not to let that bias me as much as possible. Yeah, like I said, I, I think a company is a net negative for society and isn’t even an attractively valued then it’s an easy pass.

[01:17:51] Shawn O’Malley: I also wanna mention that if you’re wondering how you can track the intrinsic value portfolio, we’ll build on this show each week to see our position sizes and holdings. You can sign up for our free newsletter in the show notes below. We’re at the investors podcast.com/newsletters, and you’ll get weekly outlines of our company breakdowns, portfolio, and even valuation models for the stocks we cover.

[01:18:13] Shawn O’Malley: So with that, let me say thank you again, Daniel, for joining me. It’s been a ton of fun. Hopefully you’re not offended by, by my rant on big food companies. It sounds like maybe you, you agree without giving away, the company will be pitching next week. Why don’t you just give us a little teaser about what, what listeners should expect.

[01:18:29] Daniel Mahncke: Well, what I can say is that we will get another company at least as long as associates in terms of brand and pricing power. I do hope though, that we see a bit more growth going forward, and I think that should be enough of a teaser. I think you know what to do. If you want to hear about it, just tune in next Sunday.

[01:18:48] Shawn O’Malley: Cool. Alright folks, that’s all for today. Let me leave you with a quote. As always, Starbucks iconic former CEO Howard Schultz reminds us that quote, authentic brands don’t emerge from marketing cubicles or advertising agencies. They emanate from everything the company does. To Hershey’s Credit, it’s powerful brand emerged from 130 years of nearly singular focus on chocolate and sweets, and that authenticity and focus ties back to its ambitious founder Milton Hershey. So we’ll be back again next week with another stock breakdown in valuation. See you guys then.

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