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Capitalizing On Our Candy Cravings

Posted: Aug 01, 2007 15:40 PM by Dean Lundell

Tickers in this Article: HSY, CSG, NSRGY, WWY, ACL

Does anyone you know ever pass up a piece of chocolate? Probably not. The world has a sweet tooth, so we're going to take a look at three confectionery companies who are cashing in. You might assume that being in the candy business is like having a license to print money, but as you read on you'll find that some sweets can be poisonous - to your portfolio anyway .

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More Than Just Chocolate
With a market capitalization of over $145 billion and sales over $70 billion, Nestle SA (OTC: NSRGY) is the 800-pound gorilla in the sweet market. To be fair, Nestle produces more than just chocolate; the company is the world's leading manufacturer of food with operations in coffee, bottled water, dairy products, prepared food, pet food and of course confectionery products.

Financially, the company does well with a year-over-year sales growth of 16% and year-over-year net-income growth of 30% - a marked improvement from the previous year. For a company this size, this is quite an achievement.

Nestle is in every corner of the globe and sports some very strong brands such as Perrier, Ralston Purina and Nescafe`. If you happen to put on a few pounds eating Nestle chocolate, the company also owns Jenny Craig to help you drop the extra weight. The firm announced its acquisition of Gerber and it even owns a 75% interest in Alcon, Inc (NYSE: ACL) which makes contact lens solutions. Nestle could be considered the industry benchmark.

Off the Bottle
Cadbury Schweppes PLC (NYSE: CSG) plans to be a pure confectionery company with the eventual divestiture of its North American beverage business. Management will then be able to focus on what it does best. Cadbury is the leading confectionery business in the world with roughly a 10% market share with a third of its revenue coming from emerging markets. (For greater insight, see Re-evaluating Emerging Markets.)

Cadbury has a good track record of innovation as demonstrated by its liquid filled chewing gum. This gum was only introduced a year ago, but its already in 13 different markets, generating about £200 million in annual sales. However, CSG also has a track record of making some less than lucrative acquisitions. This growth by acquisition has resulted in some burdensome expenses that will have to be excised.

Cadbury's future plans include eliminating obvious and easy expenses and centralizing its operations. To generate more sales the company plans on leveraging its global network to sell more premium products to developed countries while introducing more cost-effective products to emerging markets.

Lacking Variety
Most everyone in North America is familiar with Hershey (NYSE: HSY). So, it's not surprising to learn the company derives 90% of its revenue from the North American market. However, this is also the problem. Hershey needs to break out of this status quo operation. There are plenty of other markets to invade and addictions to satisfy.

Financially, Hershey does quite well, achieving an earnings growth rate of over 17% and a very impressive 85% return on equity. Unfortunately, share performance has not reflected this level of success.The company owns 30% of the U.S. market, with Mars a distant second at 17%. The extent to which Cadbury will give Hershey a contest is unknown at this point because of conflicting licensing agreements.

Hershey, with operations in the United States, Canada, Mexico and Brazil, clearly needs to break out of this myopic operational venue. Mars will certainly give HSY a contest as will Wrigley (NYSE: WWY). The problem could be that Hershey has a dual class of shares with the Milton Hershey Trust owning the 10-to-1 Class B voting shares. All in all, the trust has an overwhelming control over the company. The aggressiveness of HSY's board will determine the company's future success.

Impulse Buyers Beware
Many of the products these three firms sell come in the form of impulse purchases at the check-out counter. One has to wonder what impulses the market has. During the past two years, Nestle has appreciated roughly 40%, Cadbury gained about 20%, and during that same period Hershey has actually declined roughly 30%. You'll have to make up your own mind if this is a sweet deal or not.

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By Dean Lundell

Dean Lundell is a former vice president at Merrill Lynch Capital Markets, a principal of a regional investment bank, an independent futures trader and licensed commodity trading advisor. He has written for McGraw-Hill, the Chicago Mercantile Exchange and several financial magazines. Prior to his career on Wall Street, he served with the 82nd Airborne Division in Vietnam.

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