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Hershey (HSY) Beats on Q1 Earnings; Lowers 2016 View

The Hershey Company HSY beat the Zacks Consensus Estimate for earnings but missed the same for revenues in the first quarter of 2016 due to continued weakness in demand in China and North America.

Moreover, the chocolate giant lowered its sales and earnings expectations for 2016 due to weak category trends.

Concurrent with the earnings release, the company announced the acquisition of New York-based private company – Ripple Brand Collective. The acquired firm owns the barkTHINS premium chocolate snacking brand. Financial details of the deal were not disclosed.

Earnings Beat

Hershey’s first-quarter adjusted earnings per share of $1.10 beat the Zacks Consensus Estimate of $1.05 by 4.8%. Earnings inched up 0.9% year over year as lower advertising spend and a lower share count – following share buybacks in the quarter – offset the weak top-line performance.

Adjusted earnings exclude derivative mark-to-market losses, charges related to the productivity initiative, non-service related pension expenses and a favorable settlement of the Shanghai Golden Monkey (SGM) liability. Including these, reported earnings were $1.06, down 5.5% year over year.

Revenues Remain Weak

Net sales of $1.83 billion missed the Zacks Consensus Estimate of $1.91 billion by 4.2%. Net sales, including the impact of currency, declined 5.6% year over year. Currency hurt revenues by 1.2 percentage points (pp) which was greater than management expectations.

Excluding the currency impact, sales declined 4.4% due to weak volumes and soft pricing.

Net price realization, mainly in the U.S., hurt sales by 0.5 pp, much less than 1.0 pp benefit in the previous quarter. Moreover, volumes declined 4.3 pp because of lower sales in China as well as weak sales in North America owing to a shorter Easter season.

Hershey’s top-line performance has been weak since 2014 due to soft international sales due to macro headwinds, changing consumer shopping habits and intense competition from the broader snacking environment in the U.S. Notably, in 2015, sales trends were hurt significantly by currency headwinds and slower-than-expected sales performance in China. In fact, the U.S. business performance was below expectations in the last two quarters of 2015 due to slowing marketplace consumption trends.

Segment Discussion

North America net sales declined 4.3% to $1.63 billion. Excluding currency headwinds of 0.4 pp, sales decreased 3.9% due to lower pricing and volumes. While pricing deteriorated 0.7 pp, volumes declined 3.7 pp due to a shorter Easter. However, the acquisitions of Krave (Mar 2015) and Allan Candy (Dec 2014) as well as the divestiture of Mauna Loa resulted in a net benefit of 0.5 pp.

First-quarter net sales of Hershey’s International and Other segment plunged 15.4% to $195.3 milliondue to lower sales in China and India. Currency impact hurt sales by 7.3 pp. Mauna Loa divestiture adversely affected sales by 0.7 pp. Excluding currency headwinds, sales dipped 8.1% due to weak volumes. While pricing rose 1.0 pp, volumes declined 8.4 pp.

Constant currency sales grew 4.2% in Mexico and 9.6% in Brazil. However sales plunged almost 37% in China due to lower sell-in related to Chinese New Year items.

Weak consumer shopping trends due to economic slowdown and softening chocolate category trends have been hurting Hershey’s sales in the country since 2015. In the first quarter of 2016, China chocolate category retail sales fell about 10%.

Further discontinuance of some edible oil products hurt sales in India in the first quarter and led to a constant currency sales decline of 33.4%.

Margins Up

Hershey’s adjusted gross margin increased 20 basis points (bps) to 46.8% as greater-than-expected supply chain productivity, costs savings, and slightly favorable commodity costs partially offset higher other supply chain costs.

Excluding advertising, selling, marketing and administrative expenses (SM&A) decreased 9% as Hershey is deliberately reducing non-essential spending to leverage existing resources. SM&A includes investments in non-advertising brand-building and go-to-market capabilities in both the U.S. and international markets.

Advertising costs declined 10% due to lower promotional spending in the quarter. With new product launches as well as merchandising and display activity in North America expected to accelerate as the year progresses, advertising costs are expected to shoot up.

Operating margin expanded 120 bps to 21.5% helped by higher gross margins and lower advertising costs.

The adjusted effective tax rate was 35.0%, same as last year.

2016 Guidance Issued

Net sales are expected to inch up 1.5% in 2016, less than 2% previously. The guidance was lowered despite an anticipated positive impact of 0.5% from the barkTHINS acquisition.

The guidance, however, includes a negative impact of 1.0 pp from currency. Excluding the impact of currency and acquisitions, net sales are now expected to increase around 2.0%, less than 3% as stated earlier. Lower-than-expected non-seasonal CMG category trends through the rest of the year prompted the revision.

Gross margins are expected to be below the 2015 levels. Previously, margins were estimated to remain in line with 2015 margins. Unfavorable sales mix is expected to hurt gross margins.

Adjusted earnings per share are expected in the range of $4.24 to $4.28, which represents around 3–4% growth. The guidance has been lowered from the prior expectation of $4.36 to $4.38 due to expected barkTHINS dilution of $0.05 to $0.06 per share.

Even after adjusting for the barkTHINS dilution, the company’s earnings guidance lies in the $4.29–$4.34 per share, also below prior expectation.

However, beginning 2017, the annual productivity savings target was raised from about $50–$70 million a year to about $100 million per year through 2019. In 2016, Hershey expects to generate incremental savings of $10–$15 million.

Stocks to Consider

Hershey carries a Zacks Rank #3 (Hold). Some better-ranked food stocks are Kellogg Company K, The J. M. Smucker Company SJM and Pinnacle Foods Inc. PF. All three stocks hold a Zacks Rank #2 (Buy).

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HERSHEY CO/THE (HSY): Free Stock Analysis Report
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PINNACLE FOODS (PF): Free Stock Analysis Report
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