Hersheys and Mondelez; Investing in Chocolate – Part 2

Those who invest in cocoa should put their money behind bars. Chocolate bars that is! 😀 Earlier this week in part 1 of my investing in chocolate series I wrote about the insatiable global appetite for chocolate and how to make money from that. 🙂 Today I’ll go into details about how I plan to do it.

Last week I purchased about $4,000 USD of chocolate companies, Hershey Co and Mondelez International Inc. 😀 Both are major players in the chocolate space and own some very high quality products and valuable brands. I bought 20 shares of HSY and 50 shares of MDLZ, which is roughly $2,000 of each company.

As we can see I bought these 2 stocks in my US dollar TFSA for efficiency. I’ll post a tutorial on how to open a registered $USD account in the future if anyone’s interested. For now let’s go over some analysis to understand why I believe these companies should be in my long term investment portfolio.

The Hershey Company

Famous investor Warren Buffett said one of the secret formulas to a successful business is to “buy commodities, and sell brands.” That is exactly what Hershey is doing. 🙂 It purchases sugar, milk, cocoa, etc, and sells products that have major brand recognition. About half of the chocolate consumed in America is milk chocolate, and that is what Hershey is known for. 🙂 If someone goes into a candy store to buy a Hershey chocolate bar and the store owner says “sorry, we don’t have Hershey, but we have this other generic brand that is 20% cheaper,” then the customer will probably leave and try to find another store to get his Hershey fix. 😆 That is the power of brand loyalty. It automatically puts a 20% value premium over other businesses offering the same food. Check out some of the awesome brands Hershey is responsible for.

Hershey’s global reach is surprisingly wide, and Forbes has ranked the Hershey brand 5th overall. Hershey is America’s largest chocolate producer with 43% of the U.S. chocolate market. It sells products in over 2 million retail outlets in 50 different countries under 60 brand names and growing. 😀 Most of its sales come from the U.S.

One of the metrics I at when analyzing a stock is its earnings growth and sales growth, in other words, the bottom line and revenue trends. So let’s take a look at its financials. Revenue = total sales. Earnings = after tax profit.

The 5 year earnings and revenue growth looks pretty healthy to me. 🙂 Each year the company sells more products and makes a larger profit than the year before. That’s the sign of a good investment. The current EPS of Hershey is about $4. The stock is trading at roughly $94 today. If we divide the stock price by the EPS we get the P/E ratio of 23.5 times. The lower this number is the more undervalued the stock is. Historically speaking 23.5x is a decent valuation for Hershey. Here is the PE ratio of the stock over the last 5 years. If the PE ratio is currently over 30x then I would be hesitant to buy. If the PE ratio is too high there will be the risk of PE compression which will lower the price of a stock.

With an expected profit of $4 per share I should make $80/year on this investment with my 20 shares of HSY. That’s better than leaving money in a savings account. 🙂

Another factor I look at is how many institutional investors have stakes in the investment. For Hershey about 3/4 of the shares are held by pension funds, sovereign wealth funds, and other large institutions so I’m more confident in holding HSY for a long time.

The final variable I look at is the analyst’s recommendations. According to Thomson Reuters there are 15 stock analysts who have opinions about HSY. Most of them give Hershey a “hold” rating, but there are a few positive sentiments as well. Ideally I would have liked to see more optimism from analysts on HSY. At the moment it appears Wall St. doesn’t see a lot of future growth with HSY, but at least there is no “sell” recommendation. Other than this neutral outlook, I still believe Hershey is a good stock to buy and hold because of the other positive signals I’ve mentioned.

Mondelēz International Inc

Mondelez (MDLZ) is an North American multinational confectionery, food and beverage conglomerate, employing around 107,000 people around the world. The stock is a bit overvalued at 29 times PE ratio but I think its a good complimentary investment to hold alongside my HSY shares because Mondelez has 44% of its business in emerging markets. There’s a lot of opportunities in the growing consumer middle class of Asian, South American, and Eastern European households. Mondelez is 3 times larger than Hershey by market cap. It is one of the top players in biscuits, candy, gum, and of course, chocolate. 😀 Most of those categories have very little private label competition, which is good for pricing. Here are some notable Mondelez brands.

As a kid I used to see commercials for many of these products on the telly. Little did I know back then they were all from the same company! 😛

I have some mixed feelings about the financials of Mondelez. It’s sales look to be stalled over the last few years but the earnings growth is quite respectable.

Most analysts do seem to like Mondelez. It’s also a good sign that it has surprised the market with better than expected business numbers for the last 5 consecutive quarters of financial reporting. 🙂

Risks

Investing in chocolate companies comes with risks just like any other venture. Input costs such as cocoa, milk, sugar, and nuts are volatile and can make it more expensive for these companies to make their products. Here’s the price of cocoa over the last 25 years. The large swings show this commodity is not for the faint of heart. 😕

This volatility is influenced by factors such as weather conditions, pests/disease, speculation and political instability. Luckily large chocolate producers like Hershey and Mondelez have the purchasing power to hedge against price instability and also pass the increased cost of production to consumers in the form of higher prices. It may leave a bitter after-taste with chocolate lovers but it’s a winning business strategy. Hershey has been raising its wholesale prices over the years as the ingredient it buys become more expensive. #foodinflation.

The Last Bite

A few large players in the growing chocolate market means sweet times ahead for investors in those companies. 🙂 With global chocolate confectionery sales growing each year I look forward to mouthwatering returns from my 2 new stock purchases. 😀

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Random Useless Fact:

In 100 years Google Maps will have a street view feature called “retro” that will show what towns looked like in 2015