Three chocolate stocks to sweeten your portfolio

More than 150 years old,  Nestlé SA (NSRGY) is the world’s largest food and beverage company by annual sales. It clocked around US$90 billion in revenue in 2017, with offerings like Nescafe, Perrier, Pure Life and Purina, and iconic chocolate brands like KitKat, Milkybar and Aero. Nestle also owns more than 23% of French cosmetics company L'Oreal.

With 34 brands that each generates more than US$1 billion in annual sales, it commands favourable shelf space and charges premium prices for many of its products. Morningstar equity analyst, Ioannis Pontikis, recently upped the stock’s fair value from US$82 per American Depositary Receipt (ADR) to US$84, prompted by nearly 3% organic sales growth for the nine months of 2018.

“Nestle’s volume growth is at the high end of the food and beverage industry, a good indication that its ability to defend shelf space is intact,” a Morningstar equity report said. “Population growth, urbanisation, and economic growth are secular drivers in emerging markets, where the company sources a sizeable and growing share of its sales.”

The management has been pushing to improve margins through structural cost-cutting while spurring growth (mid-single-digit target by 2020) through active portfolio management (acquiring/divesting businesses), and greater investment in high-growth categories including coffee, pet care, water, and nutrition.

Nestle enjoys strong competitive advantage, or a wide moat, underpinned by vast global distribution platform, an entrenched position with retailers and a durable cost edge. These attributes help Nestle carve out a global market position that is tough for new entrants to match, says Pontikis.

Leading U.S. confectionery maker,  Hershey (HSY) holds just under half of the domestic chocolate market. The firm’s product portfolio of more than 80 brands includes well-known names such as Hershey’s, Reese’s, KitKat (the company owns the rights in the U.S.), Twizzlers, and Ice Breakers, sold across 80 countries.

“Hershey operates as a leading player in the confectionery space, expanding its market share over the past five years to around 45% of the U.S. chocolate industry, with its top five brands generating more than US$5 billion in annual sales”, says a Morningstar report.

That’s not all. The firm is investing strategically to bring new products to market, including "hand to mouth" offerings, to differentiate its offerings from the competition, says Morningstar sector director, Erin Lash, who assigns the company a wide economic moat, built on brand intangible assets and cost advantage.

The company, she adds, is taking proactive steps to realize US$150 million to US$175 million in costs savings to fuel added brand investment and enhance profits. Hershey’s enviable brand portfolio is best positioned to charge higher prices without impacting volume. This reinforces its competitive advantage and makes Hershey a valued partner for retailers, asserts Lash, who recently raised the stock’s fair value from US$116 to US$117, prompted by strong cash generation. She projects 3% to 4% annual sales growth and operating margins improving to 24% by 2027 from 20% over the past five years.

A leading player in the global chocolate and snacks market,  Mondelez International (MDLZ) is owns popular brands like Cadbury, Toblerone, Oreo, Halls and Chips Ahoy. The company’s product portfolio includes biscuits (41% of sales), chocolate (30%), gum and candy (15%), beverage (5.5%), and cheese and grocery (10%).

Mondelez dominates the global snacking arena with biscuits (16% share of the worldwide space) and sugar candy (9% share). It holds the top spot in confectionery markets in Latin America (controlling nearly a quarter of the market), and in Western Europe (more than 17% share).

The confectioner’s robust competitive advantage rests on the economies of scale derived from its vast global network, with approximately 80% of revenue generated outside North America. The competitive edge is further “buoyed by its entrenched retail relationships, stemming from the vast resources it expends to support its portfolio of well-known brands [seven of which rack up over US$1 billion each in sales] and ultimately aiding retailers’ quest to drive traffic into outlets,” says a Morningstar report.

The firm’s new CEO, Dirk Van de Put, has implemented tactical initiatives as he targets 3%-plus sales growth longer term. Further, Mondelez is taking steps to save US$1 billion in excess costs, primarily by extracting further complexity from its operations, which could include shedding unprofitable brands and upgrading manufacturing facilities, Lash notes.

“A portion of any savings realized would fuel additional spending behind its brand mix (in the form of R&D and marketing), supporting the intangible asset that underlies its wide economic moat,” says Lash, who pegs the stock’s fair value at US$52, and projects 3% to 4% annual top-line growth through 2027, and 20% operating margin expansion by the end of the decade.