Hershey, an American Icon, Tries to Regain Its Former Glory

By , Money Morning •

By Jennifer Yousfi
Managing Editor

With all the challenges The Hershey Co. (HSY) faces, the travails of the American candy making icon can really be summarized with one simple fact: In an increasingly global market, Hershey depends on its home U.S. market for 80% of its sales.

Hershey needed to make a move that would better position it to reach overseas markets and capitalize on fast growing consumer classes in emerging markets while enjoying the currency benefits of non-dollar denominated sales.

In January 2007, a merger with United Kingdom-based Cadbury Schweppes PLC (CSG) seemed to be just what was needed for both firms. Cadbury was looking to focus on its core businesses while increasing its presence in the United States. At the same time, it offered Hershey an opportunity to increase its international presence, something Hershey desperately needed as U.S. sales continued to slow.

Unfortunately a deal that made perfect sense to many soon went horribly awry.

For reasons unknown, former Hershey Chief Executive Officer Richard Lenny downplayed his talks with his counterpart at Cadbury, Chief Executive Officer H. Todd Stitzer. In January, The Wall Street Journal reports, Stitzer met with Lenny to discuss a merger between the two firms. Lenny promised to take the offer to the Hershey Board of Directors.

And while Lenny did mention it at the next board meeting, it was only in passing and late in the meeting. People present at the meeting left feeling the offer wasn't serious. It wasn't until Stitzer made a comment to London-based analysts that Cadbury was interested in a Hershey merger that The Hershey Trust Co. President and Chief Executive Officer Robert Vowler became aware of the offer.

What followed were several rounds of back and forth sniping between Hershey's management, board of directors and its principal shareholder - the Hershey Trust Company.

Vowler accused Lenny of intentionally withholding information from the Trust. And when the candy company reported weak second-quarter earnings in July, the Trust again felt betrayed. The feelings of ill will eventually led to Lenny's retirement on Oct. 1, 2007 and the subsequent removal of other board members.

In the fall, the Trust tried to take things into their own hands and approached Cadbury again about a possible merger. But things had changed in the past several months as the unfolding credit crisis wrecked havoc on the U.S. economy. Cadbury was no longer interested.

Hershey would have to save itself.

"It's kind of a perfect storm for them," Walter Todd, a principal at Greenwood Capital Associated LLC in Greenwood, South Carolina, which sold its Hershey shares last year, told Bloomberg News. "They've got the input cost situation, which is squeezing margins, they're having to spend more on advertising, which is squeezing margins, and the competition is more intense."
Net income plunged 65% in the fourth quarter to $53.4 million, or 24 cents per share, from $153.6 million, or 65 cents per share, in the year prior. For the full year, net sales only increased 0.1%.

Even more troubling, Hershey reduced its profit forecast down from $2.08 in 2007 to just $1.85 to $1.90 per share in 2008. Hershey blamed significant increases in commodity prices for the reduction as ingredient and energy costs continue to soar. But Hershey is also losing market share to domestic rival Mars, Inc., which faces the same rising costs.

Birth of an American Icon

Founded by Milton S. Hershey in 1894, The Hershey Co. is one of the oldest American manufacturing firms.

Milton Hershey started out as a caramel maker, but quickly learned that the money was in the milk chocolate business. He sold his caramel company in 1900 and focused his energies on milk chocolate confections. He used the proceeds from the sale of Lancaster Caramel Company to buy 40,000 square acres near his hometown and build his first chocolate plant in 1903, in the town that would later come to bear his name, Hershey, Pennsylvania.

Hershey always cared about his workers. He wanted them to be comfortable and entertained. With that in mind, he built comfortable homes in Hershey and even built an amusement park, Hershey Park, which opened in 1907. During the Great Depression, Hershey undertook several construction projects in town to help keep people employed. Those projects resulted in The Hotel Hershey, Hershey Theater and the HersheyPark Arena and HersheyPark Stadium.

In 1918, after the early death of his wife, Kitty, Hershey made one of his most influential decisions. He left his entire fortune to the school he and his wife had established. When Hershey died in 1945, a sizeable portion of Hershey Co. stock came under the control of The Hershey Trust Co. The Trust also took control of Hershey Estates, which was renamed Hershey Entertainment and Resorts Company, a privately owned company which controls many of the facilities and sites in the town of Hershey.

Hershey's first chocolate plant outside of Pennsylvania was opened in 1963 in Canada in the town of Smith Falls, Ontario. Two years later, Hershey opened a third factory in Oakdale, California.

But rising labor costs and soaring raw ingredient prices have taken a toll on Hershey, causing it to make some unpopular decisions.

In 2002, seven members of the Trust board of trustees voted to sell the Trust's controlling stake in Hershey to Wm. Wrigley Jr. Company (WWY) for $12.5 billion. But when confronted with pressure from Pennsylvania Attorney General Mike Fisher and the Community of Hershey, the sale was eventually abandoned. The members of the board who had voted to sell were eventually replaced.

Recipe for a Turnaround

Hershey is up against a host of problems. It's being crippled by high commodity and labor costs. The candy maker is overly dependent on a weakening U.S. market. And it hasn't kept apace of changing consumer tastes.

But the company is taking steps to address all three areas of concern.

In an effort to cuts costs, Hershey announced it would be closing its California and Canada-based plants. The company also has plans to lay off about 10% of its 14,000 employees. Hershey is opening a new factory in Mexico where labor costs will be lower. It's an unpopular move for some, and has been the target of an e-mail boycott campaign.

Hershey is also trying to reach out to international markets to capitalize on fast growing emerging markets and stronger currencies abroad. In 2007, Hershey embarked on two joint ventures in the red-hot economies of India and China.

In India, Hershey partnered with Godrej Beverages and Foods, Ltd. to manufacture and distribute Hershey's Syrup. Over time, additional products will be introduced. The joint venture is expected to have annual sales of $70 million.

Hershey also has partnered with South Korea-based Lotte Confectionary Co. in an attempt to reach the Asian markets in a cost-efficient manner. The two companies estimate that the market for chocolate in China is worth $639 million and plan to focus on the Shanghai region where sweet treats fit local tastes and consumer spending is strong.

Meanwhile, Hershey is introducing two new product lines at home in the States, an attempt to woo back customers who prefer "premium" chocolate. The chocolate maker is partnering with Starbucks Corp. (SBUX) to offer candy in retail locations. Hershey is also debuting a new line of high quality chocolates under the Bliss brand.

Focusing on premium and dark chocolate is likely to help Hershey's overseas sales as well, since many international customers prefer it to milk chocolate.

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