This Chocolate Maker Can Deliver Sweet Returns

Hershey’s (HSY) have left a bitter taste in investors’ mouths of late. Shares have melted some 20% from their January high and now sit near a 52-week low at $88 a share. But at this point plenty of bad news is priced and the stock offers a good buying opportunity.

The company has been hurt by higher cocoa prices, which have risen by 30% over the past six months pinching margins. Weak consumer shopping trends due to economic slowdown, increased competitive activity in the chocolate category and strong competition from online sales and a general shift in consumer preferences for healthier snacks such as fruit and nut bars have led to slower than expected growth.

It also has seen steep sales declines in China, which it had hoped would drive growth. Last September it acquired an 80% stake in Shanghai Golden Monkey, the 2nd largest Chinese chocolate maker. But in April it revealed that China sales declined 47% year over year in the first quarter. The weakness continued in April and May forcing Hershey to reassess its strategy and reevaluate its plans purchase the remaining 20% next September.

Lowering the Bar

All of this has led Hershey to retrench and lower its guidance. On June 22nd shares declined almost 3.5% after it slashed the sales and profit outlook for 2015 and announced 300 job cuts. This was the second such lowered sales and layoff announcement in past three months. The company is now expect sales to grow just 2.5%-3.5% down from the 5% forecasts.

Earnings for fiscal 2015 are now expected to $4.25 per share on $7.6 billion sales. At this point shares trade at 20x forward earnings. That’s still somewhat rich for a mature business with low single digit growth.

But Hershey’s commands, and deserves, a slight premium due to its brand and leading market share. While it has encountered some bumps in China, it and other emerging nations especially in South America, offer double digit growth opportunities. Hershey’s has the infrastructure and distribution networks to tap into these new markets which aspire to iconic American brands such as Hershey.

At this point it seems most of the disappointment has been priced into.   The shares have held important support along the $88 level. Indeed, even on Monday with the overall market tanking Hershey’s shares held firm and have shown good relative strength today.

HSY chart 6.30.15

This offers a good risk/reward entry point. By using low cost, long dated options we further limit our risk while maintaining solid profit potential.

The Trade:

I’m targeting the purchase January 2016 LEAPs with the $85 strike for $6.25 a contract

I have a price target of $97 per share but would look to take partial profits if the value of the calls reach $10 or a 65% gain prior to the expiration date.

To further reduce risk I would use a close below $86 per share as a stop loss for exiting the position.

— Steve Smith

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About the Author: Steve Smith