Motley Fool Hidden Gems Investing - Who Killed the Candy Bar?

Episode Date: October 29, 2022

If you’re looking for a market-beating stock then you don’t have to go much further than the candy aisle. Ricky Mulvey and Asit Sharma gear up for Halloween and discuss: - Why candy is a growing market that’s also shrinking - Hershey’s M&A strategy and supply chain questions - Official Halloween candy power rankings Companies mentioned: HSY, GIS, NKE Michele Buck’s HBR article: https://hbr.org/2022/11/the-ceo-of-hershey-on-turning-a-candy-company-into-a-snacks-empire Host: Ricky Mulvey Guest: Asit Sharma Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hartigans. Don't know them yet? Then Google us. From the underworld of Guy Ritchie. Do you want to step up the ladder?

I want Comet dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren. Do I have to do everything myself? You want more? I'll give you more! Mobland, new season hits September 18th Paramount Plus. Asit, this sounds like a lovely community

event, and it does not involve candy. Okay, so let's switch from onion rings to one of the myriad flavors of milkshakes that are also very popular at Cookout. Also not a candy. Not a Halloween candy. If somebody gave my

child, if they dumped a milkshake into his candy bag on a Halloween trick-or-treat, I think everybody involved might be a little bit upset about that. Chris Hill Here on Motley Fool Money, we take our Halloween candy power rankings very, very seriously. I'm Chris Hill, and with just hours to go before Halloween, Ricky Mulvey and Asit Sharma

are diving into the business of candy. They'll take a closer look at Hershey's market-beating strategy and why shrinkflation is hitting your trick or treat bag. You know what's back this year is shrinkflation, which is nothing new for candy, according to a Washington Post story. In the 1950s, candy companies told vending machine operators that they would have to raise prices going from $0.05 for a piece of candy to $0.06. The vending machine folks balked and asked that the candy companies just make the products smaller. You're seeing this across the board with consumer goods in general, Asit, but I think you're seeing it extraordinarily prominently.

Extraordinarily prominently, is that a phrase? You're seeing it prominently in the candy space, at least from my consumer experience. Yeah. As you point out, this has been going on for a while, Ricky. I think one of the things that makes candy such an easy target for shrinkflation is that we have innovation in packaging, right? There's not a lot of innovation in some of the small pieces of candy, small items you'll pop into your mouth, but we come up with ingenious ways to divide them up into smaller pieces to then individually shrink wrap those pieces within a larger package. The machines get more automated every year. I know I've been studying collaborative robots or co-bots and their ability to now pick and pack stuff. When you can show a CFO that,

look, we can just shrink this a little more this year because the packaging just got a little bit lighter and our profits are going to go up, they love that. This is going to go on until, I don't know, several generations from now, Ricky, your descendants will be using a microscope to find their candy when they open a package, but they'll still be paying the same price as they were. Your family was in 1950, same package. Financial engineering killed the candy bar. According to the Washington Post story, a bag of dark chocolate Hershey Kisses is now a couple of ounces smaller than before. Two pack of Reese's cups is a tenth of an ounce lighter, and Cadbury milk chocolate bars are 10% skimpier. Another example that I got was from

at JennySWave25 on Twitter because I was complaining about the size of what Hershey is now calling a king-size bar. It is Quaker Oats Instant Grits. She used to get 12 in a pack. Now, she's getting 10. Now, they're slightly less than one ounce. I think you're seeing that most prominently in the chocolate space. I'm going to show you an example because for this show, I did some consumer research, Asit. I went down to the 7-Eleven to see what Hershey was offering, because we're going to talk about the company more in depth in a moment. You're so dedicated. I'm a Peter Lynch investor, which means I see products in my everyday life, and then I either

buy the stock or not based on no more research. This is what Hershey's is calling a king-size bar now. It is 2.6 ounces. It's basically, if you're imagining this at home, it's enough chocolate to cover about two s'mores and this is what is now being called a king size bar so to your earlier point where you're saying these candy companies are getting cute with the financial like engineering and the different robots doing packing stuff i would counter that sir and say that in many cases they're just simply lying about what constitutes a king size amount of chocolate the question is are we gullible or are we just addicted are we gullible enough to say oh that's king size, that's going to do me, or maybe I need two king sizes, or are we just addicted?"

At the end of the day, we go through the aisle, we grab a couple, three king sizes because we don't care anymore what we pay, we need our chocolate fix. Let's put the spotlight on some Halloween slash candy companies. The one I've been diving into a little bit is Hershey. Founded in 1894, it's been on the New York Stock Exchange since 1927. When you think of a market-beating company, you might not think of the Hershey Chocolate Company. However, it's a dividend night. We did a show with Matt Argersinger and Anthony Chavone a while back. They found a list of companies that fit into these categories. It's paid a dividend for 10 or more consecutive years. It's grown that dividend by more than 10% annually over 10 years, and it's

beaten the Standard & Poor's 500 over that 10-year period. Asit, are you surprised to learn that Hershey fit into that category? Because when I was in business school, Hershey was one of those stodgier ballast-like companies where you're not expecting a market-beating return, but you're also not expecting to lose your money by investing in the stock. I'm surprised and not so surprised by that, Ricky. I've had a conversation with Maddy recently about dividend stocks in which which we were both pointing out that the expectation of providing a steady dividend or the expectation to increase that dividend makes you run a business in a responsible way. This solid cash flow business which has been around for so long has a good chance of at least trying

to keep up with the rate of inflation. That's what good consumer goods, multinational companies try to do. They try to grow their revenue at or above inflation. A couple of percentage points above is a great target. Now, why it is a little surprising is because in this day and age, you have to make the right bets. We've seen a lot of consumer goods companies that also play in the chocolate space by pet food companies to get that extra kick in revenues. If you think about Mars, which is privately held, if you look at General Mills, which has some candy exposure. These are companies that are buying into premium spaces in the CG world. It's fraught with risk because you can make the wrong bets.

This tells me that Hershey is doing okay in its M&A strategy, which I know you wanted to talk about, but this is one of the hardest things to do in the CG world. When you've been the stodgy business, how do you grow? How do you buy the right companies to give you that extra bit of sauce where someone like Ricky Mulvey will come and say, yeah, this is a dividend night. I like this. This is interesting. I'm not saying you're a dividend night or not. That's based on the spreadsheet numbers. Yeah. Hershey has been big on the M&A. CEO Michelle Buck wrote in a Harvard Business Review piece, if you're curious about how Hershey has turned the business into a market

beater, I highly recommend the article. And she says that her goal was to turn it from an iconic confection company to a leading snacking powerhouse. It's made a couple of acquisitions, including Amplify Snack Brands, which includes Skinny Pop and Packy Spicy Tortilla Chips. Pirate Brands, which includes the Pirate's Booty Snacks that you've seen in a grocery store, and also Dot's Pretzels. It's a part of that better for you kind of strategy. They're not going to call it healthy. They'll call it better than a piece of chocolate. If you look at the growth categories for Hershey, Pirate Brands and Dot Pretzels, the sales growth after the acquisition has been growing by at least 30%, 40%. And I think to your earlier question,

it's because Hershey's able to go in and say, we have a lot of capabilities that can help you grow your sales. We know how to sell food to people at a mass scale. And that makes those mergers and acquisitions an easier sell for those companies. I mean, this is a very interesting strategy. What you just named, the brands that Hershey acquired, they're actually at the intersection of two or three categories. They are in that good-for-you circle. They're also in that occasion circle. I've got Movie Night, and they're also in what's called the indulgent or semi-indulgent category. You want to treat yourself. You might pick up a bag of Pirate's booty some people because it's not quite as bad for you as another choice, so you're more likely

to buy it. Skinny Pops, the Pocky's, Pocky's spicy tortilla chips are some people's substitute for Doritos. So in that intersection of three circles, they made the right bets. And this, again, is what I say is very difficult when you become a multi-billion dollar CG conglomerate to pull off. I think this is where Michelle Buck might have had an edge in the past few years. The other thing I'll notice, they didn't overpay for any of these franchises. None of these were deals that were so big that they had a risk of actually harming the bottom line. I believe Amplify was actually a publicly traded company. If memory serves, maybe there was a little bit of stock as well involved in that deal. Now, write in and let us know if my memory is wrong.

But these were smart acquisitions too. Besides acquisitions, I think Michelle Buck laid out the strategy in the Harvard Business Review article and said that the company had been leaning too heavily on product innovation to drive growth. To your point of Family Movie Night, she started focusing more on packaging and when do people consume Hershey's products. We investigated consumer occasions on which our products could play a role, such as Family Movie Night. We developed a more user-friendly way to buy our brands. For example, those are the resealable stand-up bags that can hold up in a pantry in packs of single-serving treats. And I think that makes a lot of sense for the company, which is you've kind of already figured

out the product line. Now it's just figuring out ways to make it more readily available for consumers. Before we move on, Ricky, can we zero in on one word that you just mentioned, which is line. Typically, when you're looking for innovation in this space, what you're really doing is asking the question, how can I just have SKU proliferation? You think the answer is having different versions of the same products and lots of them. That's most of the time what we see in consumer goods. When CEOs and CFOs talk about product innovation, that's really what happens. And then you've got to figure out how do we get this through lines? And I'm talking about manufacturing lines. Oftentimes it doesn't help the business at all. But I think this is another

level of thinking that Hershey put in. Again, it's a little more purposeful and a little more targeted at something that's going to drive an incremental return on investment. So I sort of love this thinking. Expanding and contracting product offerings is nothing new. When Milton Hershey had started making candy, at one point he had more than 100 products. He had to focus on caramels and then chocolate. It's interesting to see this similar problem play out more than 100 years later. For the stockiest of stock investors in the back of the room, we got 4.7 price to sales. It's about 48 times price to free cash flow. We've got 23% return on invested capital, a 43% gross margin, and Buck's been responsible with the share count. 205 million

shares outstanding now, 211 million shares outstanding in 2018. So even with the acquisitions, you're not seeing an exploding share count for the Hershey Company. Asit, you're the analyst. I just host podcasts around here. Any of those metrics stand out to you? You know, if I found these metrics out in the wilderness, I would say that 48 times free cash flow, that sounds high to me. But now, you've presented this on a trailing basis, but you also present us, Ricky, with a 23% return on invested capital, which is pretty darn good for a manufacturer of this size. I do also like the reduction in share count. I'm not a huge fan of share buybacks if there are really persuasive uses for that capital. But

in a mature business, sure. I mean, after a few decades, let me see some reduction in share count if you've got some excess cash that you're either generating or it's lying around on the balance sheet. Those all stand out to me as reasonable, somewhat attractive. you look at this 43% gross margin and think to yourself, that also sounds like a pretty mature business. Now, bear in mind, Hershey's has had decades and decades and decades to try to push above, I don't know, a 50%, 60% gross margin. But as you told us at the beginning of this taping, Ricky, selling candy, selling consumables isn't the highest margin of businesses. On the surface of things, I would say Hershey is doing a pretty decent job with these fundamental

metrics that you've laid out for us. I'm looking into adding some ballast companies to my stocks. Here are my concerns with Hershey. One of which, this is my consumer So, I went to the 7-Eleven. I got the king-size bar of Hershey. And when I looked at the price of just a regular old Hershey bar, I've realized that it's now more expensive to buy Hershey's chocolate than it is to buy a lot of what I would call a more premium competitor. There's a company called Tony's Choco Colony. And they're selling these six-ounce bars for about, I think it's about $5. And then the price per ounce for this premium chocolate bar is now less expensive than what Hershey is giving me through their cool shrinkflation tactics. So that's number one.

And then second of all, I think there's still a lot of supply chain concerns that I have with Hershey. They release very long ESG reports. And while I think it's great that they're focusing on board diversity, when I go on my Hershey's chocolate bar and I scan the QR code to find out where the chocolate is coming from, it takes me to a broken webpage, which tells me that they're not going to tell me. And I really don't like it because I think for something like chocolate, where you have a very fraught supply chain, where you're getting the cocoa from a lot of these West African countries with small growers, where there are things that can go very, very wrong for the people working in that area, you have to be extraordinarily transparent about how that's

going and where the chocolate's coming from. Yeah. I mean, Ricky, the first of those two points is a question of brand risk. And the second of those two points is a question of appetite. So, you know, to the first, you're definitely onto something there. Every brand that is really, really established with every generation, they have to reestablish themselves. Nike goes through this problem. They're an example of a company that does brand extension really, really well. As one generation ages, the next generation wants a pair of Nikes. Why? Because Nike is very persuasive on TikTok. They're in the metaverse. They spend a lot of money on technical innovation, so their products are usually good. Hershey is up against some

splitting in consumer preferences. You do have a raft of almost, they look like bulk candies, as you've mentioned, some big chocolate bars right at the checkout in colorful packaging to attract maybe some younger consumers, and then this explosion of candy bars. You know the type I'm talking about where they show you the percentage of cocoa on the wrapper and they mix in some hazelnut or something. Will the younger generations still have the loyalty to Hershey's that older generations did? That's something we'll have to find out. any other any other halloween candy companies you want to talk about talk we can talk about tootsie roll we can talk about pepsico or do we want to move on to our power rankings you know

we have to do power rankings we have to do people what they want ricky i reached out to some fools and i asked for the top halloween candy power rankings and you would be surprised at what we received because in some cases it wasn't actually candy so dan boyd man behind the glass you want to come in and help us out with some Halloween power rankings. Absolutely. Asit, I'm going to let you go first. What do you have for your top three Halloween candies? All right. So Reese's, you got to have Reese's. And this is based on years and years of midnight snacking. Number two, for me, those small snicker bars that are just such a joy to unwrap. You want to just find another one after you've you've eaten the last one you're riffing around in the dregs of the bowl to find

one more snickers package and number three onion rings not a candy doesn't yes this doesn't count okay so this was supposed to be by locality right so in my locality i wanted to give a shout out to the older generation anyone who's above 13 or 14 maybe has a driver's license because where i live in north carolina it's becoming more and more of a tradition to go to a place called cookout which is a sort of shotgun type drive-thru that has in nearly every city in which they set up shop a long line of cars at 2 and 3 a.m and i should be honest here not just on halloween but like every weekend so awesome this sounds like a lovely community event and it does not involve candy dan you okay so let's switch from onion rings to one of the myriad

flavors of milkshakes that are also very popular at cookout also not a candy halloween candy if if somebody gave my child if they dumped a milkshake into his candy bag on a halloween trick-or-treat that i think everybody involved might be a little bit upset about that fair enough i will then go with watermelon flavored jolly ranchers that's a candy okay i i'm much happier dan boyd do you have a list of like of beef jerky or potato chips you'd like to add for your top three i have i have had chocolate covered potato chips before uh which were pretty good but i'm not going to count them as halloween candy because i uh you know not a crazy person so you respect the rules i will go with my number one is the mini size snickers now

i looked up the snickers size chart before the show here so i was accurate in this this is this is of course the smallest size snickers you can buy uh my my my thing with those is like i can't really eat a full snickers bar on its own i think it's too rich it's too much you know but i'll eat about a hundred of those mini size snickers in one sitting if you let me uh so those things are pretty great second is the kit kat i like the crunch that's really it it's just a good crunch and third and this is a little bit of a dark horse and i think might anger some people out there is the heath bar whoa yeah bar i love the heath bar the crunchy toffee on the inside oh you can't beat it man i think with the with the mini snickers bar it's all about the ratio because

with a regular snickers bar you're just getting too much filling and then you're not getting the chocolate on the end so it's not that it's not that perfect bite once you get into the middle of it we should specify you're talking about the one that's not the size of like my fun two knuckles you're talking about the one that's like the size of a quarter one yeah this is the smallest one yeah that's the best one it's got the correct ratio of chocolate to filling if we're going to be honest here dan boyd celebrating shrinkflation uh i've got three surprised i haven't heard it yet i've got sour patch kids number one that's that to me is obvious it is first it's sour then it's sweet it's two candies in one don't shake your head respect the sour patch kid number two

it's the mini reese's dark chocolate it's very specific but i think the peanut butter mixed with the darker chocolate is a significantly better combination with than than the milk chocolate okay number three the kit kat that's an easy one also the mini size simple crunch that's all you need and then i'm going to give two honorable mentions because these are these are candies that aren't necessarily halloween candies but they are candies unlike osset's list of potato chips and beef jerky milkshakes um milkshakes excuse me i try we've got uh we've got the i think it's more popular internationally but it's these copico coffee hard candies that are like these like sweet coffee yeah candies that are actually they're pretty good and then out of

cincinnati ohio the french chew mini it's these like tootsie roll size little um saltwater taffy things that are absolutely delicious and you can get them in vanilla strawberry banana and it's just a delightful little treat that takes me back to the boardwalks of cincinnati ohio ricky mulvey getting both hyper regional and international at the same time you love to see it i should say low culture and high culture as well that dark chocolate uh description made me realize what a connoisseur ricky is thank you uh and then two more as we wrap up because i reached out to other fools on in chocovaloo he gave us three snickers reesey cups peanut m&ms and the non-chocolate runaway winner of sour patch kids i think that was just to hide his chocolate and peanut bias

i mean he's right though like thumbs up chocolate candies are always better than non-chocolate candies on halloween for sure dylan lewis kit kat sneakers reese's and then an honorable mention to almond joy and gushers dylan lewis i wish you were here because gushers is not a halloween candy that is something you put in a lunch as a fruit snack yeah did you say sneakers there i thought he did because i i mean like listen i like wearing shoes as much as the next guy but i ain't about to eat you know i'm about to eat my vans i'll eat him but i need some chocolate on him there you go that's as good a place of any as to to end the candy industry focus uh asa charma always good to see you dan boyd thanks thanks for chatting candy with us you're welcome ricky so much fun

gents as always people on the program may have interest in the stocks they talk about and the motley fool may have formal recommendations for or against so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.