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Three stocks that could offer sweet returns

Why chocolate makers and suppliers look tempting.

Vikram Barhat 8 December, 2015 | 6:00PM
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For investors who have a financial sweet tooth, chocolate is much more than just a festive treat. Select chocolate makers and suppliers appear to be tempting investments, based on their sound fundamentals, leading brands and current stock prices that are well below their fair values.

The chocolate confectionery market is a US$80-billion-a -year global industry, according to the Irish research firm Research and Markets. It projects compound annual growth of 5%, in terms of revenue, from 2014 through 2019.

When combined with the decisions of leading chocolate companies like Hershey's and Lindt, among others, to raise prices last year by as much as 8%, some of these stocks appear to be mouth-watering prospects. Some commodity stocks are also well positioned to benefit from the growing demand for chocolate, especially in emerging markets.

The Hershey Co.
Ticker HSY
Current yield 2.58%
Forward P/E 19.5
Price US$86.82
Fair value US$102
Data as of Dec. 4, 2015

The largest U.S. confectionery manufacturer,  Hershey Co. (HSY) has a 45% share of the domestic chocolate market. The 85-year-old company has a product portfolio of more than 80 brands, including household names such as Hershey's, Reese's, Kit Kat, Twizzlers and Ice Breakers, sold in more than 70 countries.

Hershey's wide moat, or competitive advantage, is tightly wrapped in a solid brand mix, significant clout with retailers and cost advantages, according to a Morningstar report. The company is in the process of venturing outside the confectionery business by expanding its product set. Meanwhile, it's pushing to ramp up its confectionery business in China, where it controls 10% market share, the report said.

"These efforts should prove advantageous longer term, and drive our forecast for international sales growth (about 10% of the firm's total sales) at a high-single-digit rate beginning in 2017," says Morningstar equity analyst Erin Lash. She puts the stock's fair value at US$102, which implies a free-cash-flow yield of 4%. She projects 4%-5% sales growth over the longer term and operating margins of 22% by fiscal 2022.

On a year-to-date basis, the stock price is down more than 10%, making it an appetizing treat for investors hungry for value.

Mondelez International Inc.
Ticker MDLZ
Current yield 1.39%
Forward P/E 21.3
Price US$44.14
Fair value US$50
Data as of Dec. 4, 2015

 Mondelez International Inc. (MDLZ) is a leading player in the global chocolate and snacks market. With popular brands like Cadbury, Toblerone, Oreo, Halls and Chips Ahoy, its portfolio consists of biscuits (38% of sales), chocolate (31%), gum and candy (15%), beverages (6%), and other packaged grocery products (10%).

With a strong brand mix (nine brands generate more than US$1 billion in annual sales each), and an expansive global footprint, the firm is a stalwart in the global packaged-foods arena, according to a Morningstar report.

Mondelez holds a 15% share of the global chocolate market, and controls an industry-leading 18% worldwide market share in the biscuit category, says the report.

"The strength of the firm's competitive positioning is evident in its adjusted returns on invested capital (ROIC), which have historically exceeded our 7% weighted average cost of capital estimate," said Morningstar's Lash. Her forecast calls for the company's ROIC to reach 17% over the next five years.

Mondelez is committed to realizing significant cost savings over the next several years. This prompted Lash to raise the fair-value estimate for the stock to US$50, up from US$45.

"We expect Mondelez's cost savings to ramp up to its target of US$1.5 billion by fiscal 2017, but expand to US$2 billion by fiscal 2019," she says, adding that 60% of these savings "will drop to the bottom line," while the remaining 40% will be invested in marketing and research. Lash projects net profit margins to expand to 16.8% by 2018, and to 17.3% by 2024.

Archer-Daniels Midland Co.
Ticker ADM
Current yield 3.11%
Forward P/E 11.4
Price US$35.74
Fair value US$49
Data as of Dec. 4, 2015

Agricultural conglomerate  Archer-Daniels Midland Co. (ADM) is an indirect play on the chocolate market. You won't see its name in the chocolate and candy aisles, but the company is nonetheless a major player. It produces corn syrup and sweeteners, liquid sucrose, dietary fibre, food oils, gums and many other products that are used in chocolate, confectionery, bakery and dairy products.

ADM is also a major processor of soybeans and corn. As part of its drive for global expansion, it's looking for opportunities to expand in emerging markets, particularly China.

"The soybean-trading business has benefited from increased Chinese soybean consumption," says a Morningstar report. "Demand will increase as China's population and income per capita both advance."

Steady growth in crop yields and new land brought under agricultural production, particularly in South America, are likely to lead to an increase in crops transported around the globe, says Morningstar equity analyst Jeffrey Stafford.

"This bodes well for ADM's agricultural-services business, and we expect tepid but fairly consistent volume growth in this area," says Stafford. He places the stock's fair value at US$49. That's nearly 26% higher than its current value, and implies fiscal-year price/earnings of 17.5 times and enterprise value/adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) of roughly eight times, based on 2015 estimates.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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