Bittersweet times for Hershey

In the midst of a major streamlining programme and having just signed an outsourcing deal with Swiss chocolate producer Barry Callebaut, these are certainly interesting times for the established US confectionery giant Hershey. But, asks Dean Best, could this activity be the prelude to the 'transformational' deal which some analysts believe the company needs?

Over more than a century, Hershey has become synonymous with chocolate in the US and has grown to become the nation's largest candy producer. However, with US consumers switching to healthier snack alternatives - and faced with growing competition from the likes of Mars, Hershey has had problems on its home turf over the last year.

The US chocolate market as a whole is only growing at around 2% a year and Hershey has not been quick enough to tap into rising demand at the premium end of the category where growth is fastest. A lack of marketing investment behind its core products has also been a critical factor behind the falling profits at Hershey in recent months.

In response, Hershey has embarked on a streamlining programme that will axe 1,500 jobs and cut its production lines by a third, freeing up more cash, the company hopes, to breathe fresh life into its brands. What's more, Hershey hopes that the launch late last year of premium chocolate like Cacao Reserve will start to pay off as the company moves through 2007.

Last week's outsourcing deal with Barry Callebaut is also vital for Hershey. With demand for standard chocolate stagnating, Hershey wants its partnership with the Swiss premium chocolate producer to strengthen its position at the upper end of the US chocolate market.

Despite Hershey's moves to reposition itself domestically, analysts are concerned that the group is at risk of being too dependent on its home market. Hershey is relatively unknown abroad, especially compared to the likes of Cadbury Schweppes and Nestlé, and has hitherto been unable to exploit booming demand for chocolate in small, but potential high-growth markets like India and China.

Outside the US, Hershey has moved to catch up with Cadbury and Nestlé, this year signing deals with local groups in India and China. However, Alexia Howard, an industry analyst at US investment bank Sandford C. Bernstein, believes Hershey has "boxed itself in".

"They had already really optimised their position in the US chocolate market and when you've done that, the problem is that you have nowhere to go," Howard tells just-food. "Now, they've got to get a move on with their international expansion."

Howard says that competition from the likes of Mars in the US is putting Hershey's domestic profits under pressure, leading to its decision to take "an even bigger axe" to its cost base in North America. "The market is growing at 2% on average and their margins are very, very high already," Howard says. "They had thought they could push them higher but for the competition of Mars, so it's become increasingly hard to generate margin expansion."

It seems that 2007 - and perhaps 2008 - will be a time of transition for 107-year-old Hershey. Core brands like Reese's have already received much needed investment in a bid to regain share from Hershey's competitors in the US. However, it will be months at least before Hershey reaps sustained benefits from that investment.

And it will be years before Hershey generates substantial earnings from markets like China, India and Mexico, where it is in the middle of building a new plant. "It will be a bit of a slog in Asia," insists Howard. "Hershey is being very savvy; joint ventures are a good way to go. However, you have to work to build consumer awareness of your brands. You have to be prepared to pay to play to a certain extent. To get distribution, you have to commit to a certain level of brand support to just get people to carry your product." Moreover, in Cadbury, Nestlé and Wrigley, Hershey will be up against competitors who have been heavily involved in India and China since the 1990s.

It could be argued that Hershey needs a "transformational" deal to rejuvenate its business. Since March, when Cadbury announced it would divide its global confectionery business from its beverage operations in the Americas, there has been speculation that Hershey may be interested in the UK group's candy assets.

Cadbury made a move for Hershey in 2002 but the bid collapsed. Howard, however, thinks a second Cadbury bid for Hershey would be "unlikely" with US activist investor Nelson Peltz holding a stake in the company. "I don't think he'll entertain the idea of Cadbury buying Hershey."

However, Howard also thinks Hershey could team up with Wrigley or a private equity group to bid for Cadbury's confectionery business. "(Hershey) could struggle to bid for Cadbury by itself as it would need to pay a premium and Cadbury is a bigger company. However, Hershey could benefit from an acquisition as it would increase their global presence."

And with problems at home, Hershey may well need to look abroad to reap a brighter future.