RBC: 3 Reasons Why Hershey's Valuation Could Start To Melt

Chocolate and snack company Hershey Co HSY continues to transition from a traditional candy company to "filling out the snacking wheel," according to RBC Capital Markets, but the sell-side firm named two reasons preventing it from recommending the stock.

The Analyst

Analyst David Palmer maintains a Sector Perform rating on Hershey's with an unchanged $104 price target.

The Thesis

Hershey's stock historically carries a three-turn P/E multiple premium versus its food rivals, and for good reason, Palmer said in a Friday note.

The snack company boasts far more predictable sales given the impulsive nature of its products, a portfolio of "powerhouse" brands and superior pricing power due to its chocolate share dominance and minimal competition from private labels, the analyst said.

Investors are right to question how sustainable Hershey's multiple is over the long-term, Palmer said.

The analyst named three factors he said could could result in the erosion of the premium valuation:

Lower convenience store visits due to changing commuting habits, higher foodservice mix and declining gas trips.
Lower supermarket traffic.
Consumers turning to e-commerce channels for food purchases.

Another key question Palmer said investors are asking: what role will salty snacks from the core brand and the Amplify acquisition have in 2019?

During the fourth quarter of 2018, salty snack consumption rose 3.5 percent — which is better than the 1-percent growth seen in the center store grocery category and flat core chocolate candy consumption, according to RBC.

Looking forward to 2019, the Hershey's Bar with Reese's Pieces continues to ramp production, but its performance so far trails other recent launches, Palmer said.

The next wave of innovation remains unclear, and the higher year-over-year freight and input cost pressures seen in the fourth quarter of 2018 could only diminish in the back half of 2019, which could result in lower gross margins, the analyst said.