Can Hershey survive candy wars?

By The Wall Street Journal

Hershey (HSY, news, msgs) this week laid out plans to battle the global candy giant to be created by the Mars-Wrigley merger, but offered little detail on how the iconic chocolate maker will address its overwhelming reliance on the U.S. market for revenue.

At an investor update in New York, Chief Executive David West said Hershey would boost spending on marketing about 20% this year and next. He also slightly increased the company's long-term annual sales targets and outlined plans for new products.

But it isn't clear those steps will be enough in the coming candy wars.

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When Mars, maker of M&Ms, and Wm. Wrigley Jr. (WWY, news, msgs), maker of Juicy Fruit and Doublemint, combine in a $23 billion deal expected to close in a few months, the new company will have broad global reach. And that will put Hershey, whose business outside the U.S. represents just 14% of sales, in a difficult spot.

Consummating a long-time flirtation with Cadbury (CBY, news, msgs) would give Hershey broader international scale. But over the weekend, LeRoy Zimmerman, chairman of the Hershey Trust, the company's controlling shareholder, reiterated the trust's refusal to cede control of the Pennsylvania chocolate maker and owner of the Hershey's, Reese's, Kit Kat and other brands.

In an opinion piece published Sunday in the Patriot-News of Harrisburg, Pa., he wrote, "Simply put: We will not sell the Hershey Co." Hershey Trust spokesman Tim Reeves said that Zimmerman wouldn't comment further.

After the article was disseminated by a Wall Street analyst, shares of Hershey fell 6% Monday to close at $35.87. They fell again Wednesday, the day after West addressed shareholders.

West set a new long-term annual sales growth target of 3% to 5%, compared with the previous goal of 3% to 4%, and an earnings-per-share growth target of 6% to 8%, down from the earlier 9% to 11%. Hershey affirmed its 2008 earnings forecast of $1.85 to $1.90 a share, but West said that Hershey won't hit its target in 2009 because of expected higher commodity costs.

With the Mars-Wrigley combination looming, Hershey's options appear increasingly limited. To acquire Cadbury, which is valued at about $17 billion and is more than twice its size, Hershey would need to find a significant investment partner and would probably need to borrow a considerable sum.

Hershey could find itself in an even tighter bind if another company, such as Kraft Foods (KFT, news, msgs), makes a play for Cadbury, as some analysts have speculated. A Kraft spokesman declined to comment on deal speculation but said one of the company's criteria for acquisitions is determining that it can "build scale in international geographies, especially in emerging markets."

West offered scant guidance on how the company plans to expand globally beyond saying it will continue entering into joint ventures and making acquisitions in Asia and Latin America.

No. 1 in chocolate

He told investors that Hershey will take on Mars-Wrigley by competing aggressively in the United States.

"Although the Mars-Wrigley deal could affect our ranking, we remain well positioned on many dimensions, especially in chocolate, where we have a 43% share" of the $16 billion U.S. market, he said. "We are more convinced than ever that our core U.S. business can grow."

Not enough, said Credit Suisse analyst Robert Moskow. "My concern is that the international footprint they now have in these emerging markets is very tiny. The real focus internally seems to be squeezing more growth out of the domestic market." Moskow has the equivalent of a "hold" rating on Hershey stock; his firm has an investment-banking relationship with Hershey.

Hershey has struggled in recent years as it neglected core brands in favor of pushing limited-edition products. That opened the door for Mars to introduce new Dove dark chocolates and other items that stole market share from Hershey.

'Engaged exploring munchers'

West told investors that Hershey marketers have talked to tens of thousands of consumers to determine why and how often they buy candy.

They identified six core consumer groups, including "loyal indulgers," or older consumers who are loyal to specific brands, and "engaged exploring munchers," who are the least price-sensitive and most profitable.

The company is now developing products targeted at these groups, West said. New Reese's Whipps -- a chocolate bar with a fluffy peanut butter and nougat filling -- is aimed at consumers seeking less fat, while Reese's Select Clusters -- chocolate-covered pieces of nuts, peanut butter and caramel that resemble turtle candies -- target consumers who want to indulge.

To appeal to women between the ages of 25 and 49, the company launched creamy bite-size pieces of milk or dark chocolate called Hershey's Bliss. Hershey has also worked with Starbucks (SBUX, news, msgs) to develop a new line of chocolates in such flavors as Caramel Macchiato and Madagascar Vanilla Bean.

West said the company will increase marketing spending about 20% this year to more than $155 million, and plans an additional 20% increase next year. The company is also trying to make grocery-store candy aisles easier to shop by testing new displays that group products by purchasing occasion, such as movie candy, gifts and items for the candy dish.

This article was reported and written by Julie Jargon for The Wall Street Journal.