CULTURE
The development of The Hershey Company’s culture started with the founder, Milton S. Hershey. Milton believed that “workers who were treated fairly and who lived in a comfortable pleasant environment would be better workers” (www.hersheys.com). With this philosophy, he developed a town that would provide for the employees’ welfare. He developed a town that was unlike many other company towns, which often took advantage of workers. The town he developed included housing, schools, churches, parks, a convention hall, department stores, an amusement park, swimming pools and a trolley system. Milton recognized the importance of community and his employees’ well-being, as evident by his development of Hershey Park in 1910. Initially the park was developed as picnic grounds but was expanded to include a playground, a band shell, swimming pool, a zoo and a bowling alley. In addition to building a town for the company’s workers, Milton and his wife created the Hershey Industrial School in 1909 for orphans. This school ensured orphans primary needs: food, clothing and lodging. These were met along with other needs such as physical training and education. Milton gave his entire fortune to the school which included the ownership of the Hershey Company. Milton is known as a humanitarian whose deeds are still benefiting thousands of people today. His value system is demonstrated by the following quote: “He measured success, not in dollars, but in terms of a good product to pass on to the public, and still more in the usefulness of those dollars for the benefit of his fellow men” (www.hersheys.com).
Milton’s dedication to his employees and education is present in the Hershey Company today. The Hershey Company offers their employees many different developmental and education programs including training workshops, educational assistance programs which include full tuition refunds, management training, cross-functional job assignments, and membership in professional organizations. Further, the company offers programs to enhance the quality of work-life. These programs help employees balance work demands and family or outside obligations. Examples of these initiatives are flexible work times, discounted childcare, on-site fitness centers, sabbaticals for education, volunteer recognition programs and employee counseling (company.monster.com/hershey/). These programs are symbols that show the company is committed to their employees’ lives at work and at home. In addition to being committed to education and employees’ work-life balance, the Hershey Company is also committed to diversity. The company has many groups that support the different demographics at the Hershey Company. These groups include a new hire support team, a corporate and sales diversity council, affinity groups for both minorities and women in sales, an African American group, and a Hispanic group (www.diversitycareers.com).
The Hershey Company and their employees, like the founder Milton Hershey, follow the values of community and volunteerism. The company and employees support organizations such as the American Red Cross, YMCA, the Partnership for a Drug-Free America, Children’s Miracle Network, United Negro College Fund, Boys and Girls Club, the National AIDS Fund, Habitat for Humanity and the Juvenile Diabetes Research Foundation. The company is also committed to Fitness and health. This is seen in the on-site fitness centers at The Hershey Company and the sponsorship of the Hershey’s Track and Field Games, which is a youth sports program (www.hershey.com).
The Hershey Company’s culture is one that focuses on people. The rich history of charity and compassion that Milton Hershey provided his company is still prevalent today. The culture is demonstrated by the company’s internal programs, organizations, and groups and the company’s external good deeds and support of their community. The following quote expresses how employees and others view the Hershey Company: “It’s nice to come to work for a company that when you say the name, people smile” (www.diversitycareers.com).
LEADERSHIP
The Hershey Company Executive Team
Richard H. Lenny, Chairman of the Board, President and Chief Executive Officer
Mr. Lenny was elected Chairman of the Board, President and Chief Executive Officer of The Hershey Company effective January 1, 2002. From March 2001 to December 2001, he was President and Chief Executive Officer of the Company. Before coming to Hershey, Mr. Lenny worked for Kraft Foods, Inc., the largest packaged food company in the United States, where he served as Group Vice President of Kraft Foods, Inc. and President of its Nabisco Biscuit and Snack business. He is also a director of the McDonald’s Corporation. (www.forbes.com) Mr. Lenny received his Bachelor’s in Business Administration (BBA) from Georgia State University in 1974 and his Master’s in Business Administration (MBA) from Northwestern University in 1977. Lenny’s memberships include Hershey Board (chairman), Hershey Trust, McDonalds Board, Sunoco Board, Georgia State University Foundation (trustee), Grocery Manufacturers of America (chairman) and Pennsylvania Business Roundtable (www.nndb.com).
Richard Lenny is considered to be a transactional leader. A transactional leader is a leader that focuses on policy and structure. Transactional leaders are said to use management by exception, where they adopt the old adage “if it is not broken then it need not be fixed.” Transactional leaders also have a clear routine (www.changingminds.org). Richard Lenny’s leadership style is specifically evident in an interview with James Owens from the Marshall School of Business at University of Southern California, Lenny stated that his motivators in this business are “energetic and engaged people who are committed to delivering superior performance across three dimensions: financial, strategic and organizational.” He also spoke of the legacy that he wanted to leave at Hershey. That legacy, he states should be “a system that’s both self-sustaining and self-perpetuating” (http://www.marshall.usc.edu).
David J. West, Current President and soon to be Chairman of the Board, Chief Executive Officer former Executive Vice President, Chief Operating Officer
As Chief Operations Officer, Mr. West is responsible for day-to-day operations of the company including international operations. West was previously the Chief Financial Officer at Hershey. David West is a native of Pennsylvania. He received his Bachelor’s in Business Administration from Bucknell University in Lewisburg, PA. He began his career with The Hershey Company in 2001 as the Vice President of Business Planning and Development. Before his tenure at Hershey, West was with the Kraft Company, Nabisco Division. He has also worked for Wearever Proctor-Silex and Unisys (www.thehersheycompany.com).
In December 2007, when West assumes the position of Chief Executive Officer and Director of the Company, many are hope that he will be a transformational leader. A transformational leader is one which works predominately the vision of the company. They define the vision, excite and convert followers, sell the vision and map out the progress of the vision (www.changingminds.org). Mr. West needs this sort of mentality and leadership style in order to help them grow into new markets and to financially boost the value of The Hershey Company.
Humberto P. Alfonso, Senior Vice President, Chief Financial Officer
H.P. Alfonso, a native of Cuba, graduated from Rutgers University with a bachelor’s degree in accounting. He holds an MBA in marketing from Rutgers and is a Certified Public Accountant. Alfonso joined Hershey in July 2006. Prior to Hershey he worked for Cadbury, Adams Division of Pfizer, Inc. and Warner Lambert (www.reuters.com).
Marcella K. Arline, Senior Vice President, Chief People Officer
As the Senior Vice President, Chief People Officer Arline is responsible for human resources, communications, corporate affairs, compensation, benefits, security, flight operations and facilities management for the corporation of the Hershey Company. Prior to become CPO, Arline has held numerous positions in the company; Senior Vice President, Human Resources and Corporate Affairs, Senior Vice President, Human Resources, Vice President, Human Resources, and Vice President, Quality and Regulatory Compliance (www.portfolio.com). Arline is a 1974 graduate of Virginia Tech where she studied Food Science and Technology. She is a native of Bedford, Virginia (www.vt.edu).
John P. Bilbrey, Senior Vice President, President International Commercial Group
As the Senior Vice President, President International Commercial Group, John Bilbrey is responsible for directing the company’s international businesses and executing its global strategy.
Bilbrey joins Hershey Foods from Mission Foods, Danone Waters of North America, Inc., and Procter & Gamble Company, where he spend over 20 years. (www.thehersheycompany.com) Bilbrey received his bachelor’s degree in psychology from Kansas State University. He also serves on the Board of Directors of the McCormick Company (www.k-state.edu).
George, F. Davis, Vice President, Chief Information Officer
As Chief Information Officer, Mr. Davis responsible for the Corporation’s Information Technology Integration group, the Enterprise Solutions Center, e-business/e-commerce, and EDI activities. Prior to coming to Hershey, Davis worked for Computer Sciences Corporation (CSC), Pratt & Whitney, Rocco, Inc., JP Foodservice, Inc., Black & Decker and Avon Products Inc.
A native of Kittery, Maine, Davis holds a Bachelor’s degree in Biochemistry from the University of Connecticut, and served four years as an Officer in the United States Air Force (www.thehersheycompany.com).
Thomas K. Hernquist, Senior Vice President, Chief Growth Officer
As Chief Growth Officer, Mr. Hernquist is responsible for the company’s marketing of the U.S. confectionary business, global products and for the Hershey’s Chocolate World visitors center. Prior to coming to Hershey Hernquist held positions at Fortune Brands, Vivendi Universal’s Sierra Software unit, Nabisco Inc., Entenmann’s, and Frito-Lay, Inc. Hernquist received his Bachelor of Arts degree from the University of Virginia, and his Master’s of Business Administration from Dartmouth College (www.thehersheycompany.com).
Burton H. Snyder, Senior Vice President, General Counsel and Secretary
Burton H. Snyder is responsible for the company’s legal, government relations and corporate communications functions, as General Counsel and Secretary. Snyder joined Hershey for a second time after becoming a partner with the law firm of McNees, Wallace & Nurick. He is a graduate of Lehigh University with a bachelor of arts degree in mathematics and received a J.D. from Harvard Law School (www.thehersheycompany.com).
Executive Team
Richard H. Lenny Outgoing Chairman and CEO of The Hershey Company
David J. West President and Incumbent Chairman and CEO of The Hershey Company
Humberto P. Alfonso Senior Vice President, Chief Financial Officer
Marcella K. Arline Senior Vice President, Chief People Officer
John P. Bilbrey Senior Vice President, President International Commercial Group
George F. Davis Vice President, Chief Information Officer
Thomas K. Hernquist Senior Vice President, Global Chief Growth Officer
Burton H. Snyder Senior Vice President, General Counsel and Secretary
The Hershey Company Board of Directors
The Board of Directors consists of eleven members, nine of which are independent directors. The chairman of the board is Richard Lenny the CEO. Also on the board from Hershey is David J. West, President and incumbent CEO.
Board of Directors (as of November 11, 2007)
Richard H. Lenny Outgoing Chairman and CEO of The Hershey Company
David J. West Incumbent Chairman and CEO of The Hershey Company
Robert F. Cavanaugh Managing Director of DLJ Real Estate Capital Partners
Charles A. Davis Chairman and CEO of Stone Point Capital
Edward J. Kelly Managing Director of The Carlyle Group
Arnold G. Langbo Former Chairman and CEO of the Kellogg Company (retired)
James E. Nevels Chairman of The Swathmore Group
Thomas J. Ridge President and CEO of Ridge Global, LLC
Charles B. Strauss Former Chairman and CEO of Unilever North America
Kenneth L. Wolfe Former Chairman and CEO of The Hershey Company (retired)
Leroy S. Zimmerman Senior Council of Eckert, Seamans, Cherin and Mellot, LLC and was Pennsylvania’s first elected Attorney General
The Hershey Company defines the role of the board of the directors in this manner: “The role of the directors is to exercise their business judgment in the best interests of the Company. This role includes: review of the Company’s performance, strategies and major decisions; oversight of the Company’s compliance with legal and regulatory requirements and the integrity of its financial statements; oversight of management, including review of the CEO’s performance and succession planning for key management roles; and oversight of compensation for the CEO, key executives and the Board, as well as oversight of compensation policies and programs for all employees” (www.thehersheycompany.com).
FINANCIAL ANALYSIS
INTRODUCTION
Today, with thousands of employees worldwide and $4.9 billion in revenues, Hershey is the leading maker in North America of “quality chocolate and sugar confectionery products” (www.hersheys.com). Some of their popular products include Hershey’s milk, dark, and white chocolates, Hershey’s Kisses, Kit Kat bars, Reese’s peanut butter cups, Jolly Rancher’s, Ice Breakers, and Hershey’s Snack Barz. Hershey also provides vending services, gift services, food services, and even mulching service and product for landscaping.
In the past fiscal year of 2006, Hershey increased their revenue by 2.5% to $4.94 billion and their net income by 12.6% to $559 million. Their net income per share increased almost 40 cents to $2.44 per share. With many changes in management and some large undertakings in debt for expansions, Hershey proved to have a successful year by showing increased dividends and profit. They continue to be a top company worldwide and are a noted Fortune 500 company.
In the following sections, the company’s performance over the past two fiscal years will be analyzed. A ratio analysis for Hershey will be provided giving profitability, liquidity, activity, and leverage information. Further several ratios will be compared to the industry standard and the DuPont model will be used to provide conclusions regarding Hershey’s progress over the past two fiscal years. Finally, recent stock price information and analysis along with supporting documentation for calculations will be provided.
RATIO ANALYSIS
PROFITABILITY MEASURES
From an accounting standpoint, profitability is defined as business gain in an activity. The measures used in this section detail how profitable the firm’s operations are and how well the firm generates a return on capital. The ratios for profitability analysis are return on assets, sales margin, return on equity, and the dividend payout ratio.
Return on Assets
Return on assets (ROA) measures a company’s efficiency in generating profits from its available assets. This is calculated by dividing net income by total assets. An increasing ratio indicates higher efficiency. Hershey’s ROA improved from 11.5% in 2005 to 13.4% in 2006 indicating that Hershey became more efficient over the 2006 fiscal year.
Sales Margin
Sales margin is a measure of how much net income is attained from each dollar of sales. It is measured by diving net income by total revenue or sales. As sales margin increases, it indicates that sales are increasing at a faster rate than expenses. Hershey’s sales margin improved from 10.1% in 2005 to 11.3% in 2006, indicating an increase in efficiency.
Return on Equity
The return on equity (ROE) is a measure of how well a company is able to return a profit using the shareholder’s investment. It is calculated by dividing net income by the shareholder’s equity. A higher number indicates a better return from shareholder’s investments. Hershey’s return on equity improved from 48.1% in 2005 to 81.8% in 2006, indicating a higher efficiency and better return from
shareholder’s investment.
Dividend Payout Ratio
The dividend payout ratio measures the percentage of net income that is paid out in dividends to its shareholder’s. This is calculated by dividing dividends per share by earnings per share. Hershey’s dividend payout ratio slightly deteriorated from 45.4% in 2005 to 42.2% in 2006, resulting in a lower efficiency. This could be the result of decisions to invest in other endeavors due to Hershey’s desire to grow its business. One would also draw this conclusion by noting the large amount of cash borrowed by Hershey’s in 2006.
Summary of Profitability Measures
Improvements were noted for Hershey’s ROA, sales margin, and ROE. Revenues, cost of goods sold, interest expenses, and tax expenses increased proportionally, therefore not affecting profitability measures. These improvements can be attributed to a decrease in selling, marketing and administrative (SM&A) costs, and a decrease in business realignment and asset impairment costs between 2005 and 2006. The dividend payout ratio was the only ratio to deteriorate in this group. This could be attributed to a higher reinvestment of income to other aspects of Hershey’s in order to promote company growth.
LIQUIDITY MEASURES
When talking of liquidity, typically a person thinks of how much cash he or she has readily available to pay off unforeseen short-term expenses. A company’s liquidity can be described similarly, but on a larger scale with more line items. It is defined by how easily a company can pay off short-term debts, in specific those due in the fiscal year. These measures analyze relationships between assets, liabilities, operating cash flows, net income, and capital expenditures. In this section, we will analyze the current ratio, quick ratio, cash flow adequacy, reinvestment ratio, debt coverage ratio, operations index, and cash flow return on assets.
Current Ratio
The current ratio gives a strong measure of a company’s liquidity. It compares the cash and cash equivalents plus any current assets that will be turned into cash within a year to current liabilities that must be paid within the year. This ratio indicates how well a company can pay its current debts. It is calculated by dividing current assets by current liabilities. Hershey’s current ratio improved from 0.924 in 2005 to 0.975 in 2006. Although this is an improvement, a ratio of 1 or better is desired in order to show the ability to pay of all current debts with current assets.
Quick Ratio
The quick ratio is similar to the current ratio. The difference, however, lies in the numerator. Instead of using all current assets, the quick ratio only uses cash, market securities, and accounts receivables to compare against current liabilities. This is done to further narrow the assets to those that can more quickly be turn into cash. Hershey’s quick ratio improved from 0.385 to 0.426. Although an improvement can be seen, a more desirable ratio would be closer to 1 so that debts could be paid with current cash and cash equivalents.
Cash Flow Adequacy
This ratio measures how well a company can pay its annual obligations with cash flows from operations. It is calculated by dividing cash flow from operations by the sum of long term debts, capital expenditures, and paid dividends. The ratio improved greatly from -15.329 in 2005 to 7.162 in 2006. This is due to the large amount of money generated from operations and a reduction in borrowings. This shows that operations are much more able to pay yearly debts than they were in
the previous year.
Reinvestment Ratio
The reinvestment ratio is a measure of how much a company reinvests its operating cash flows into capital expenditures. In Hershey’s case, this includes investment into property, plant, and equipment as well as capital software additions. It is calculated by dividing capital expenditures by the cash flow from operations. A decrease in this ratio is seen as good because a lower ratio typically indicates more money being distributed to shareholders. Hershey’s reinvestment ratio improved from 0.421 in 2005 to 0.274 in 2006. This is due to a large increase in cash flow from operations while keeping the investment in capital expenditures relatively constant. Therefore, Hershey’s had more funds available to distribute to its stockholders.
Debt Coverage
The debt coverage ratio determines the ability of the company to generate cash from operations in order to pay off its liabilities. The ratio is calculated by dividing total liabilities by cash flows from operations. A decrease in this ratio is deemed an improvement and indicates that the company is able to cover a larger amount of its debt with operating cash. Hershey’s debt coverage ratio improved from 7.030 in 2005 to 4.804 in 2006. This is due to a substantial increase in cash
flow from operations between 2005 and 2006. This improves Hershey’s standings and indicates that it is more able to cover its debts with operations cash.
Operations Index
A company’s operating index indicates how much (if any) of a company’s net income is needed for other operating expenses. In short, it determines if other operations in the company are providing a loss. An operating index of 1 or higher is desired and indicates that no net income was needed to cover other operating expenses. It is calculated by dividing cash flows from operations by net income. Hershey’s operations index improved from 0.945 in 2005 to 1.294 in 2006. This is largely due to Hershey’s decreased contributions to its pension plans and a smaller amount of accounts receivables trade. This improvement puts Hershey’s into an ideal range for this index.
Cash Flows Return on Assets
The cash flows return on assets is a measure of how much operating cash flows a company is generating from its assets. It is calculated by dividing cash flows from operations by total assets. Hershey’s cash flows return on assets improved from 0.108 in 2005 to 0.174 in 2006. The improvement is a result of a substantial increase in operating cash flows with assets remaining relatively constant. This indicates that Hershey’s is generating more cash from its investments than in the prior year.
Summary of Liquidity Measures
All measures of liquidity showed improvements for Hershey between 2005 and 2006. This is largely due to Hershey’s ability to generate a greater amount of operational cash flows between the two years, as seen in the cash flow adequacy. The improvement in current ratio and quick ratio shows an improved ability to pay off short term debts with current assets, which is also indicative that future payments of the long term debt will be possible. Further, the debt ratio shows improvements, meaning Hershey is in a better position to pay a greater portion of all liabilities with operating cash flows. And to further strengthen Hershey’s liquidity, the reinvestment ratio shows that Hershey has improved its ability to distribute earnings to stockholders, thus strengthening investor relations and Hershey’s position in the industry.
ACTIVITY MEASURES
Activity in a firm is typically categorized as creation of product and moving product out the door for sales. Activity measures focus on these actions and evaluate how a firm uses its assets to generate revenues. If a company is able to utilize its assets efficiently, fewer funds from financing are needed. The ratios analyzed in this section are asset turnover, accounts receivable turnover, day’s sales in accounts receivable, inventory turnover, and day’s sales in inventory.
Asset Turnover
Asset turnover takes an overall focus on how the company uses all of its assets to generate revenues. A higher number is desired because it indicates that each dollar of asset is producing a greater amount of revenue. It is calculated by dividing the company’s revenue by the total amount of assets for the current year. Hershey’s asset turnover ratio improved from 1.131 in 2005 to 1.189 in 2006. This is due to Hershey’s increase in revenues and decrease in assets between 2005 and 2006. This shows that Hershey’s was more efficient in using its assets between evaluation periods.
Accounts Receivable Turnover
Accounts receivable turnover is similar to assets turnover; however it focuses a more specifically on accounts receivable and its effect on revenue. This ratio shows how effective a company is with extending credit for credit sales as well as collecting these debts from customers. It is calculated by dividing revenues by accounts receivable. A higher turnover ratio indicates the company is efficient.
Hershey’s accounts receivable turnover ratio deteriorated slightly from 9.504 in 2005 to 9.480 in 2006. Although revenue and accounts receivable both increased over this period, accounts receivable increased at a slightly higher rate causing the deterioration of this ratio.
Day’s Sales in Accounts Receivable
Day’s sales in accounts receivable is linked closely to accounts receivable turnover. It indicates the average time in days that it takes to make a collection on a credit sale. The fewer days needed to collect, the better the efficiency. It is calculated by dividing 365 by the accounts receivable turnover ratio. Hershey’s ratio deteriorated slightly from 38.4 days in 2005 to 38.6 days in 2006. This can
be attributed to the slightly higher percentage increase in accounts receivable when compared to revenue that was noted as a source for the accounts receivable ratio.
Inventory Turnover
Inventory turnover is a measure of how often within a year that inventory is sold and replaced. It is calculated by dividing cost of goods sold by inventory. A high ratio indicates efficiency and a high rate of sales. Hershey’s inventory turnover slightly improved from 4.657 in 2005 to 4.742 in 2006. Although both cost of goods sold and inventory increased over this period, average inventory increased at a lower rate resulting in a quicker turn around of inventory.
Day’s Sales in Inventory
The day’s sales in inventory ratio is closely related to inventory turnover. It quantifies how long your inventory remains in storage. Lower numbers indicate higher turnover and therefore are considered more efficient. It is calculated by dividing 365 by the inventory turnover ratio. The ratio slightly decreased and improved from 78.4 days in 2005 to 77.0 days in 2006. This shows that inventory
hold times have improved over this time period.
Summary of Activity Measures
Both improvements and deteriorations were seen in Hershey’s activity ratios over the evaluation period. Deterioration was seen in the accounts receivable ratios, which also affected the day’s in accounts receivable. This was due to a larger percentage increase in accounts receivable when compared to revenue.
Improvements were seen in inventory and asset turnover ratios. Hershey’s assets decreased in value while revenues increased, resulting in a more efficient use of assets. And although average inventory increased, it increased at a lower rate when compared to cost of goods sold, thus indicating a higher turnover of inventory.
LEVERAGE MEASURES
A company’s leverage defines how a company handles its debt. Companies that have a high leverage can have difficulty paying back debts, securing new debts from creditors, and are usually higher risk. But, these companies can also attain tax advantages and gain large returns from investing. The ratios analyzed in this section include the debt ratio, debt to equity ratio, leverage ratio, times interest earned ratio, times interest cash flow from operating activities coverage.
Debt Ratio
The debt ratio indicates how much debt a company has relative to its assets. This ratio is calculated by dividing total liabilities by total assets. This ratio is one of the components typically used by investors to determine the risk level of a company. A lower number is favored because it shows the company has a larger percentage of assets when compared to liabilities. Hershey’s debt ratio increased and deteriorated from 0.762 in 2005 to 0.836 in 2006. This is due to a decrease in
company assets while liabilities increased. The increase in liabilities can be noted
most in the long-term liabilities. This adds risk to Hershey’s from an investment standpoint.
Debt to Equity Ratio
The debt to equity ratio is a measure of what proportions of debt and equity are used in its financing. It is also a measure of a company’s financial leverage. The ratio is calculated by dividing total liabilities by stockholder’s equity. A lower number is favored because it indicates a higher amount of shareholder’s equity when compared to liabilities. Hershey’s debt to equity ratio increased and deteriorated from 3.194 in 2005 to 5.083 in 2006. This is largely a result in Hershey’s large decrease in shareholder’s equity. Although the increase in Hershey’s debt was not very high, the company used a higher proportion of debt for financing activities thus increasing its leverage.
Leverage Ratio
The leverage ratio indicates the extent of asset financing from the shareholder’s.
A lower ratio is positive because it indicates less risk. This ratio is calculated by dividing total assets by shareholder’s equity. Hershey’s leverage ratio deteriorated from 4.194 in 2005 to 6.083 in 2006.
Times Interest Earned Ratio
The times interest earned ratio gives shows how well a company is able to pay its interest expenses with earnings before taxes. The number represents how many times over the interest expense can be paid with the earnings before interest. A higher number is favored. The ratio is calculated by dividing earning before interest and taxes (EBIT) by net interest expense. The times interest earned ratio for Hershey’s deteriorated from 9.702 in 2005 to 8.552 in 2006. Although the EBIT increased over the period, the interest expenses increased at a higher rate resulting in a lower ratio. This increases the firms risk in the eyes of the investors. TIE ratio, is largely due to a significant decrease in shareholder’s equity over the period. It further indicates that Hershey’s has increased its risk.
Times Interest Cash Flow from Operating Activities Coverage Ratio
Times interest cash flow is similar to the times interest earned ratio. However, instead of comparing the company’s ability to pay interest with EBIT, this ratio compares how well the company can pay interest with operating cash flows. A larger number is preferred because it shows the ability of a company to use operating cash flows to pay interest. This ratio is calculated by dividing cash flow from operations by the interest expense. Hershey’s ratio improved from 5.248 in 2005 to 6.231 in 2006. This is primarily due to a larger amount of cash flows generated from operations in 2006 when compared to 2005. This reduces risk and shows that the company can pay its interest more times over with operating cash flows than it could in the past.
Summary of Leverage Measures
All leverage ratios for Hershey’s deteriorated over the evaluation period with one exception. This indicates that Hershey’s risk has increased overall. Several reasons exist for this increased risk. The shareholder’s equity decreased, interest expenses increased, and long-term liabilities increased. The one thing that did improve Hershey’s risk factor was the increase in operating cash flows, which is noted in the increase of the times interest cash flow from operating activities coverage leverage ratio. These reasons prove to the investor that Hershey’s overall leverage has increased between 2005 and 2006.
SUMMARY OF ALL FINANCIAL MEASURES
Between 2005 and 2006, Hershey showed improvements in many areas. Their overall profitability improved due to a reduction of expenses, specifically the SM&A and business realignment costs. Liquidity also improved in all areas. This can be attributed to their ability to generate a greater amount of operational cash flows. Because of their increased liquidity, Hershey shows that they are in a better position to pay off their debts and is able to distribute their earnings to stockholders more readily. Activity analysis proved to have mixed results with slight improvements noted in inventory and asset turnover ratios. This indicates that Hershey’s use of assets to create revenue has improved and inventory is moving quicker from the shelves to the consumer.
Although Hershey achieved many improvements in their financial ratios, some deteriorations should be noted. In the profitability category, the dividend payout ratio deteriorated, which indicates the company is less willing to pay regular dividends to their stockholders. Accounts receivable ratios from the activity category also deteriorated, which is a result of an increase in accounts receivable. This means that there are more lines of credit out to customers, which increases the company’s risk. What is most concerning is that all leverage ratios except for one deteriorated over this period. This indicates that Hershey is much riskier than the previous period. These ratios as well as the dividend payout ratio can be explained primarily by the large increase in long-term liabilities and significant decreases in assets and shareholders’ equity. In simpler words,
Hershey has taken on debt, sold some assets, and used shareholders’ equity in order to make new investments. This proves to be a risky venture and could pay off greatly in the long term or end up costing the company millions.
Overall, Hershey has been able to increase their revenues from their basic
operations and has made a risky decision for some new long-term investments. If the trends in profitability and liquidity are indicative of future performance and the new investments prove to be profitable, then the added risk should merely act as a supplemental source to create additional capital and allow profitability and liquidity to increase at a faster rate. However, if Hershey loses significant money in their investments, profitability and liquidity will begin to deteriorate because revenue from operations will be needed to pay off the loss from investments.
Common-Size Income Statement Analysis
Overall, Hershey’s bottom line, its net income, increased by 12.6% between 2005 and 2006. This can largely be attributed to two factors. First, the selling, general, and administrative expenses decreased by 6.1%. Second, the other operating expenses, which were net business realignment and asset impairment costs, had an enormous decrease of 562.3%! This one expense was cut to less than one-fifth of its previous year’s numbers! Even though the company’s gross margin had a negligible 0.2% increase between years, and the interest and income tax expenses increased by 24.1% and 12.2% respectively, the reduction of the SG&A and other expenses resulted in a substantial increase in net income for Hershey’s.
INDUSTRY COMPARISON
Return on Assets
Hershey’s ROA of 13.45% is higher than the industry standard of 6.90%. This is a favorable statistic since a high ROA represents that a company can generate revenue from its assets efficiently.
Sales Margin
Hershey’s sales margin of 11.31% is higher than the industry standard of 6.78%.
This is favorable since a high sales margin indicates that the company is making more net income for every dollar of revenue attained.
Return on Equity
Hershey’s return on equity of 81.80% is much higher than the industry standard of 22.10%. This shows that Hershey is able to profit from shareholder’s investments at a higher rate than most companies in the industry. This is a favorable statistic.
Current Ratio
Hershey’s current ratio of 0.975 is lower than the industry standard of 1.27. This is an unfavorable statistic. The current ratio indicates liquidity and indicates how easily a company can pay current debts. A higher ratio indicates better liquidity. In order to be more liquid, Hershey’s should make efforts to reduce its current liabilities.
Quick Ratio
Hershey’s quick ratio of 0.426 is significantly lower than the industry standard of 0.61. This is an unfavorable statistic. The quick ratio is similar to the current ratio as it compares a narrower group of current assets (cash, market securities, and accounts receivable) to current liabilities. A higher ratio indicates better liquidity. Reducing current liabilities, as mentioned in the current ratio analysis, would make the company more liquid.
Asset Turnover
Hershey’s asset turnover ratio of 1.189 is slightly higher than the industry average of 1.18. This is a favorable statistic because Hershey’s is generating revenue from its assets more efficiently than the average company in the industry.
Day’s Sales in Accounts Receivable
Hershey’s day’s sales in accounts receivable of 38.59 days is higher than the industry standard of 32.33. This is an unfavorable statistic since this reflects that Hershey’s takes longer to collect its debts from its customers on credit sales. This statistic could be improved by converting more of its accounts receivable to cash.
Debt to Equity Ratio
Hershey’s debt to equity ratio of 5.08 is significantly higher than the industry standard of 1.19. This is an unfavorable statistic because it shows that Hershey’s has less financial leverage than the average company in the food processing industry. This also shows that Hershey’s has more dollars of debt for every dollar of its equity when compared with the industry.
Summary of Industry Comparisons
When compared to the food processing industry, Hershey’s performs well on most statistics. However, there are three statistics where Hershey’s falls short. The current ratio and quick ratio could both be improved by a reduction in current liabilities. Further, more sales could be converted to cash sales from accounts receivable in order to improve the day’s sales in accounts receivable. By focusing on these items, Hershey’s could see improvements in liquidity and leverage.
SUMMARY AND CONCLUSIONS
The DuPont model employs several different ratios. This model can be quickly analyzed by investors in order to compare companies from a wide aspect. It allows investors to analyze profitability, activity, and leverage of a company all in one glance. Hershey’s statistics are as follows:
Hershey’s improved all ratios in the DuPont model except for the leverage ratio. If one looks further into this ratio, he or she can see that Hershey’s has made some substantial investments in long-term borrowing. This introduces an element of risk for Hershey’s. But, Hershey’s has been improving its profitability and is performing well in many areas when compared to the industry. Further, as seen below in the table, the return on equity has improved significantly for Hershey’s. So from an investor’s standpoint, this is promising because Hershey’s is improving the way it handles its investor’s money. Therefore, investors should welcome the increased borrowing because Hershey’s is showing competency in its investing strategies by providing additional returns from its shareholder’s investments.
Although this model does give a good look at Hershey’s financial improvements, there are a few things that should be noted. First, Hershey’s has some notable competitors, such as Cadbury Schweppes, Mars, and Nestlé. Second, culture worldwide is changing to where healthier foods are much more appealing. This poses a huge challenge to Hershey’s market. Although they can create more health conscious products, the fact remains that chocolate is never going to be as healthy as many other snacks. Third, Hershey’s has taken on a great deal of long term debt in 2006. While it can be deducted that Hershey’s is investing intelligently because of increased returns from its past investments, a large sum of debt is always a risk. No one is able to predict the market.
Overall, Hershey’s appears to be in good standing in its market and is continuing to make improvements. Profitability is increasing from increased revenues, reduction in extraneous costs, and better utilization of assets. Further, liquidity is increasing from increased operational cash flows. Although its leverage has deteriorated recently, future years should see improvements if Hershey’s continues its current profitability and liquidity trends. This will make Hershey’s, which is already a good performer in the industry, a more competitive company in its market.
RECENT STOCK PRICE
Hershey Co is listed in the New York Stock Exchange (NYSE). Its symbol is HSY and recent stock price is $40.46. This is near the 52 week low of $40.20. It’s earnings per share has also decreased from $2.44 at the end of 2006 to $1.33 currently. This would show many investors that it is a prime time to buy Hershey’s stock. However, the recent retirement of the old CEO and appointment of a new CEO for Hershey’s may signal some investors to put off an investment for a while. Further, the company’s high leverage statistics shows a large amount of debt. This combined with the recent changes in management could prove to drive the stock price a little lower before it begins its upward battle in the stock market.
VALUEPRO ANALYSIS
During a recent analysis of Hershey’s stock value, two factors were adjusted in order to investigate the changes in Hershey’s intrinsic value: growth rate and beta. The growth rate of a stock is what analysts predict for the growth in revenue of a company. Beta, on the other hand, measures the riskiness of a company. For this analysis, adjustments made to the growth rate and beta was done equally to measure the affect on the intrinsic value of the stock. An increase in the value denotes a 33% increase and a decrease denotes a 33% decrease. Hershey’s initial intrinsic value with no adjustments was $43.42, which is higher than the actual stock value of $41.73.
Results from the analysis showed a strong inverse correlation between beta and growth rate. By solely increasing beta or solely decreasing the growth rate, the intrinsic value decreased by 10.5% and 12.3%, respectively. This yields an average intrinsic stock value of $38.72. This would cause Hershey’s stock to be overvalued. Further, by doing the inverse of solely decreasing the beta or solely increasing the growth rate, the intrinsic value increased by 12.9% and 12.6%, respectively. This yields an average intrinsic value of $48.98. This is significantly higher than the actual stock value, which would indicate that Hershey would be a good buy and is currently undervalued.
Additional analysis of changing both values yielded some interesting results. If both the beta and growth rate are increased of if both are decreased, the intrinsic values were $43.86 and 43.36, respectively. These small changes in the intrinsic value proved that these ratios work inversely with one another. After this analysis, the assumption was that an increase in growth rate and decrease in beta would be the optimal case whereas a decrease in growth rate with an increase in beta would be the least desired case. Experimental analysis proved this to be right. When testing the optimal case, an intrinsic value of $55.42 was achieved. This is a 27.6% increase. The inverse resulted in a 21.5% decrease of the intrinsic value to $34.54. These results prove that larger growth rates of revenue and lower risk factors will increase the intrinsic value of a stock and eventually result in an increased actual stock value.
RECOMMENDATIONS
Culture today is heavily focused on personnel health. In the past few decades, people have become much more aware of the various factors that negatively affect their health and work hard to avoid them. As a general rule, chocolate and other candy are viewed as an unhealthy snack. Therefore, Hershey needs to continue to expand and market healthy products in order to gain a greater market share. Low-calorie and low-fat chocolates are continuing to gain popularity, similar to the way that diet sodas integrated into society in the 1980s and 1990s. Also, studies are bringing new light on the dark chocolate products. Dark chocolate is beginning to exhibit many health benefits in studies ranging from improved cardiovascular performance to endorphin production to cancer prevention. If Hershey continues to market the products they already have in these categories and continues to develop new products that address the health craze of the public, then their revenues will increase throughout the years.
Hershey needs to continue to focus on the global market. Hershey currently has a limited presence in many areas of the world. They have, however, begun to expand into many new areas. Countries such as China and India are gold mines for revenue. These countries have just become industrialized and have incredibly large populations. Even a limited presence in these countries would provide a substantial increase in revenue. But, these gold mines come with their own unique set of challenges. Hershey cannot duplicate their domestic strategy and expect to be successful. They must integrate into each country’s culture and develop a strategy to immerse their brand name into these areas.
As mentioned before, 70 percent of cocoa is obtained from West Africa. The Hershey Company needs to find alternate locations such as Jamaica or different methods for obtaining the cocoa bean from the cacao tree. The West African regions are very volatile. This would allow Hershey to have more control over their raw materials and reduce their dependency on an area where political unrest is high.
Hershey should continue to provide new chocolate flavored coffee products in supermarkets and coffee stores (i.e., Starbucks, Joe Mugs). Consumers’ have grown to appreciate specialty coffees and the overall “coffee shop experience” in recent years. Further, Hershey’s name holds a great deal of clout with many consumers. This allows Hershey to market to new segments, more consumers, and participate in new trends. Further, it provides Hershey the opportunity to collaborate with the coffee manufacturing industry and other food industries.
The commercialization of many holidays is continuing to expand and the popularity of gifts for these holidays is also increasing. Hershey can provide holiday products in outlets other than their website (i.e., Hallmark, Barnes and Noble). The increase in the importance of commercialized non-traditional holidays (i.e., sweetie days, grandparents’ day, boss’s day) and traditional holidays (i.e., Christmas, Valentine’s Day, Mother’s Day, Halloween) allows Hershey to optimize the importance of their specialty gift products. By providing their gifts using retail channels, Hershey has an opportunity to increase the sale of their specialized gift products.
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The Hershey Company
Introducing the World of Chocolate
April 27th, 2010 at 3:11 pm
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