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Last June, I published “Hershey: America’s Lockdown Sugar Binge Is Unsustainable.” At that time, I had a bearish outlook on Hershey (NYSE:HSY) for various reasons. Its valuation was stretched after a strong bull market primarily driven by what I viewed as a temporary increase in candy demand during lockdowns. I also thought that rising commodity, labor, and freight costs would add extra pressure to its profit margins.
Since then, HSY has lost about 22% of its value. Its sales and profit margins have continued to rise, but its earnings forecast has slipped, with EPS stagnation expected through 2026. Its long-term sales growth outlook is also subpar. As noted in my article, it was trading at a forward “P/E” of 27X (last June), so its price was likely to decline with even a small negative revision. This can be explained in:
Importantly, I do not expect a massive reversal in the broader sales trend of chocolate and candy; however, even a stagnation at the current high level would be sufficient to make HSY considerably overvalued today.
That is essentially what has occurred. The company’s outlook shifted toward stagnation, causing its valuation to decline accordingly. My fair value target at that time was $180. It is currently just above that at $197. Much has changed since then, particularly regarding commodity input prices. Thus, it is a good time to look closer at its supply and demand drivers and valuation.
Is the Cocoa Shortage Over?
The primary change we’ve seen since last June is the tremendous increase in cocoa prices. See below:
Cocoa is about 3-4 more expensive than normal amid tremendous weather-related declines in West Africa’s cocoa production, with an estimated 18% annual decline in cocoa production. Global cocoa production is highly concentrated in countries like Ghana, Nigeria, and Cameroon in the Ivory Coast.
Ostensibly, external issues such as El Nino and Black Pod disease (and Swollen Shoot virus) are the primary cause of this crisis. However, I’d argue that the extent of the issue we’re seeing now cannot be entirely chopped up into such. Over the past years, we’ve seen extreme economic crises in most West African nations, which have faced catastrophic increases in living costs amid global inflation. That has spurred social unrest, coups, and related issues. Ghana’s economic crisis is huge amid what essentially amounts to government bankruptcy.
With that in mind, the region’s Cocoa farmers are reliant on foreign financing that is difficult to obtain, making it very difficult for those farmers to finance the necessary infrastructure to combat external issues. Similarly, the area has a lack of irrigation and other infrastructure that is necessary to stabilize these factors.
Although my point is speculative, I believe Cocoa prices will remain higher for longer. I still think they should decline from current levels. Still, we may be seeing the new normal, particularly given West Africa’s political and economic situation appears to be in a solid trend in the wrong direction. That may change, but to me, this offers Hershey similar risks to gold miners who see costs soar due to their production dependence in areas with high jurisdictional risk.
Of course, unlike them, Hershey is a middle-man, passing on higher cocoa prices to consumers. That can be seen in the PPI on the above chart, which is starting to accelerate higher amid higher cocoa prices. Over the coming months, Hershey will need to sell its chocolate products at a notably higher price to offset the issue. That said, Hershey’s chocolate and related candies often have less cocoa content than most, and the company is cutting that figure due to rising prices. Thus, theoretically, some would-be consumers of higher-quality dark chocolate may shift to Hershey’s milk chocolate to save, potentially creating an indirect benefit for the firm.
Hershey’s Income and Sales Outlook
The cocoa price increase is undoubtedly a net bearish factor for the company, mainly if we assume that this commodity pressure will last. In my view, the market assumes that it will reverse. While it should reverse as the weather issues fade, I think the shortage of both cocoa and coffee will linger for years until production in other regions increases. Still, Hershey could see an indirect demand benefit as its commodity price exposure is lower than the smaller dark chocolate companies.
The second major factor is how overall demand will change outside of pricing. Previously, I projected that overall demand for confectionary products would decline from the lockdown peak. During and after the lockdowns, US consumption of sugar products rocketed higher as many people shifted away from the previous health-centric trend. Hershey was among the few large industrial food companies to see tremendous sustained growth during the pandemic.
Since 2023, there has not been a continued increase in overall candy production, but there has also been no marked decline. See below:
This data suggests that the new normal is more candy. I find this trend interesting, as I tend toward the view that most things ebb and flow over time. It seems that periods of high social stress equal higher demand for craving items. On the one hand, it would be easy to assume that no period of high social/economic stress can last forever. Thus, there should be some inevitable decline in related candy consumption as people refocus on long-term health.
However, that view, which I believed last June, maybe proven naive. As there seems to be a permanent (or long-lasting) decline in the amount of vacation travel, personal savings, real hourly income (technically, stagnation), and consumer sentiment, there is reason to believe that most, if not many, Americans (and likely also Europeans, etc.) remain under stress. Candy may not fix an unsustainable rise in living costs and fewer vacation days, but it certainly offers the temporary respite many crave.
It is often seen that tobacco companies are recession-resistant because demand for tobacco rises during periods of higher economic and social strain. Historically, at least in the 2000s, Hershey suffered significant demand declines and financial strains during the 2008 recession. However, today, we see poor performance in most tobacco companies, which have not risen for a decade or more, implying they’re no longer recession-resistant. It seems today, that benefit has transferred to Hershey.
Given this trend’s resilience, I revise my previous view that Hershey would likely see a reversal of the 2020 demand spike. As long as we see low consumer sentiment and a large wave of healthy, sustained, and widespread economic growth (not just in a few technology firms), many people will prefer candy products. At least, that is what the data is telling me. Still, chocolate retail prices will rise significantly over the coming months as they catch up to commodities. That should hurt demand. Realistically, Halloween candy cannot have double-digit inflation forever without people parring demand.
What is HSY Worth Today?
Hershey’s sales and income are expected to remain around its TTM level over the next three years due primarily to the ongoing increase in cocoa prices. See below:
The forward valuation for HSY is now 18.8X using its two-year out (2026) expected EPS. That is notably lower than it was from 2020 to 2023. However, it reflects a reversal in its profit margin outlook and stagnation of its previously high sales growth. See below:
This data still points to an HSY fair-value target of ~$180, which was my previous estimate when it was at $253. That target was based on an adjusted valuation that assumed HSY would sustain its EPS but not its high lockdown growth rate. That is essentially what has occurred, with higher input costs being the primary driver of this shift toward stagnation.
The Bottom Line
Overall, I am neutral on HSY, revising my previous view upward. My expectation for HSY’s valuation regarding its growth has panned out, and it is now trading close enough to my fair value target.
In the future, I expect demand for candy products will remain strong but not increase at the 2020-2023 pace due primarily to higher prices. Though I am not bearish on HSY, its downside risk is still notable because so much of its input commodities are produced in areas of the world with seemingly growing jurisdictional risk.
As an example, cocoa has faced weather and disease issues before without the same shortage, pointing to larger infrastructure and political issues in areas that are worsening an environmental crisis. I currently see no positive trends on that front (the stability of sugar and cocoa-producing countries). Indeed, if Ghana follows the pattern of its peers with anti-west coups, trade issues may arise that create more significant problems for Hershey.
Further, although I am no climate scientist, many scientists see the cocoa crisis as being climate change-related. If so, there are also a few trends that show the climate issue is getting any better. So, for many reasons, I expect Hershey will see its input costs continue to rise for years, potentially faster than it can pass those costs onto customers. I am neutral on HSY now but it could turn bearish if more supply-constraining factors arise.
