Hershey Co Financial Analysis. influenced us to take a closer look into how Hershey finances their business. We were also

Transcription

1 Bridget Warlea Courtlyn Henderson Emily McCann Dr Gaffney 12/6/2016 Hershey Co Financial Analysis Introduction We analyzed the liquidity, solvency and profitability ratios of the Hershey Company, a company in the food manufacturing industry. Hoover s list their competitors as Mars Inc., Nestle and Mondelez International, to name a few. In analyzing these ratios, we saw several trends that influenced us to take a closer look into how Hershey finances their business. We were also moved to investigate any incidents that might have happened, especially between 2014 and 2015, since the company experienced significant changes in ratios during that time. When conducting a vertical analysis for 2015 and 2014, we noticed some significant changes that are worth noting. One possible reason for these changes was the fact that Hershey acquired a 100% stake in Shanghai Golden Monkey, a Chinese candy manufacturer, in Hershey had bet that China would become their second-best market by the end of 2015, but sales had remained basically flat. This misstep could be the cause of the decrease in Income before Income Taxes from 17.6% of net sales in 2014 to 12.21% of net sales in 2015, according to the income statement. Another notable shift occurs in the balance sheet, where current assets decreased from 39.96% of all assets in 2014 to 34.59% of all assets in Property, plant and equipment increased from 38.27% of total assets in 2014 to 41.92% in This change can

2 also be attributed to Hershey s acquisition of the Chinese company. In the liabilities section of the balance sheet, total current liabilities increased from 47.17% of total liabilities in 2014 to 51.62% of total liabilities in The change is largely attributable to a large increase in the current portion of long-term debt for Hershey. In 2014, long-term debt was 6.11% of total liabilities, but in 2015, it was 11.63% of total liabilities. This is a very important number for analysts to consider, as it illustrates that Hershey appears to be operating with a large amount of debt. This affects the outcomes of the liquidity, solvency and profitability ratios, as we will see in the next sections. Liquidity Liquidity is the relative measure of the nearness to cash of the assets and liabilities of a company. Put more simply, liquidity is the measure of how quickly a company s assets and liabilities can be converted to cash. The ratios that can be used to assess liquidity have to do with the company s ability to pay its debts when they come due. Hershey has seen its liquidity decrease somewhat drastically since 2013, which may be concerning as they may not be able to pay their bills when they are due. It is also concerning for them that they are less liquid compared to the industry average. The following ratios are evidence of the fact that Hershey is not in a good position in terms of liquidity. Working capital is the excess of current assets over current liabilities. Hershey s working capital has experienced a drastic decrease of % over the past three years, falling from $1,079,312 in 2013 to -$369,314 in While working capital alone cannot be used to judge the liquidity of a company, the drastic change in the working capital of Hershey is worth noting, as it indicates that Hershey has experienced major change in the past three years. According to

3 the company s 10-K form, the reason for the drastic decrease from 2014 to 2015 was due to lower inventory purchases in 2015, as they had built up raw material inventory the year before. The current ratio is the ratio of current assets to current liabilities. Over the past three years, Hershey has seen a decrease in their current ratio from 1.77 to 1 in 2013, to 1.16 to 1 in 2014, and their current ratio for.83 to 1 in This means that in 2015, Hershey had $0.83 of current assets for every $1 of current liabilities. The industry median for current ratio is 1.65 to 1. One possible reason for this decrease is that short-term investments decreased from $97,131 in 2014 to $0 in The quick ratio is a stricter test than the current ratio, as it excludes inventory and prepayments as these are the least-liquid assets. The quick ratio is a better test of the company s ability to pay its current debts as they are due. Hershey s quick ratio in 2015 is.43 to 1. This means that for every dollar of current liabilities they have $0.43 of easily-liquified current assets. According to Hoovers, the median quick ratio for the food manufacturing industry was 1.17 to 1, meaning that most companies had liquefiable assets that would cover their bills. Hershey s quick ratio is very poor compared to the industry average quick ratio. Another worry for the company is that in 2015, they did not have any marketable securities that could be liquidated to pay bills. One possible explanation for their relatively bad quick ratio is the amount of time they allow customers to pay their accounts. The more time allowed, the more cushion they have in paying their bills. Hershey s quick ratio has not always been so alarming. In 2013 it was 1.13 to 1, very close to the industry s median quick ratio. However, in 2014 the ratio fell to.55 to 1, and decreased even more in 2015.

4 Cash flow from operations to current liabilities is a way to measure the ability of a company to pay current debts from operating cash flows. It also gives a better view of the ability of the company to pay current debts over the whole year, whereas the quick and current ratios focused on a point in time. In 2015, cash flow from operations to current liabilities was 58.48%, recovering from a dip in 2014 to 50.51% from a 2013 high of 82.55%. This is encouraging for Hershey, as a high cash flow from operations to current liabilities means that they have a higher ability to pay their bills from operating cash flows. This also demonstrates that their bills are primarily paid through operations, meaning they have less savings and they use more of their residual income. The accounts receivable turnover ratio is a measure of the number of times accounts receivable are collected in a period. In 2015, Hershey had an accounts receivable turnover ratio of 12.35, meaning that accounts turned over an average of times in This is a decrease from 2014, where the ratio was 13.81, which itself was a decrease from 2013, where the ratio was This decrease is yet another indicator that the company is less liquid than it used to be. However, if we look at the number of days in accounts receivable, we can see that compared to the industry average of 42 days in 2015, Hershey is doing well with an average of just days in accounts receivable. However this has increased from 2014 when the average was days and 2013 when the average collection period was just days. It is worth noting that Hershey has a low number of days in Accounts Receivable but higher turnover, which means that they have less accounts but collect them quicker as compared to the industry.

5 The inventory turnover ratio is a measure of the number of times inventory is sold during a period. The industry average for 2015 was 7.97, meaning that inventory was turned over 7.97 times per year. This is more than the industry s inventory turnover ratio, which was 5.16 in 2015, but that may be larger due to the amount of perishable goods other food manufacturers use. Hershey s turnover ratio was 5.59 in 2014, signaling there was more demand from consumers. In 2013, the inventory turnover ratio was 5.98, which can be interpreted as being caused by greater efficiency in managing inventory as compared to both 2015 and Connected to the inventory turnover ratio is the number of days sales in inventory, with the two values having an indirect relationship. Number of days sales in inventory is the number of days between the date an item was bought and when the item was sold. In 2015 Hershey s number was 69.77, an increase from in 2014 and 60.2 in This is higher than the industry average of 45.17, which means that compared to the rest of the industry, Hershey was either less efficient at managing inventory, or their products were in less demand. The final measure of liquidity is the cash-to-cash operating cycle, or the length of time from the purchase of inventory to the collection of any receivable from sale. The cycle lasted days in 2015, compared to in This increase can be attributed to an increase in the number of days in account receivable, as the other component of the cycle, number of days sales in inventory, remained exactly the same. In 2013, the cycle was days, indicating that Hershey was more liquid in Hershey has a longer cycle compared to the industry in 2015, as the average cycle lasted days. This is due to the low inventory turnover ratio of Hershey as compared to the industry average, since Hershey actually has a superior accounts receivable turnover ratio.

6 These ratios are evidence to the fact the Hershey has become much less liquid over the past three years and is less liquid when compared to the industry average. Overall, this is cause for concern at Hershey as they move forward. Solvency Hershey Co. is experiencing significant changes in their measures of solvency, also known as the ability to remain in business long term. Through trend analysis and comparisons with industry averages, it is clear that Hershey has a unique financial structure. The debt-to-equity ratio for 2015 was a staggering 4.1 to 1, meaning that for every $1 provided by stockholders, $4.1 was from a creditor. The industry average for food manufacturing is 1.09 to 1 (Hoovers). Even more surprising than the deviation from industry average is the change over time Hershey has experienced with this metric. In 2013, they had a 2.3 to 1 debt to equity ratio, and in 2014 it only climbed to 2.7 to 1. Hershey explains these high numbers by claiming that We use debt financing to lower our overall cost of capital which increases our return on stockholders equity, which makes sense given that their stock valuations are rising. They also noted that the debt they are using for financing is long-term with fixed rates, which provides further context to their above-average ratios. Hershey Co has effectively utilized leverage for years, which is why they may appear to be a riskier company than others in the industry. Hershey s interest coverage ratio, also known as times interest earned, stands at a respectable 9.5x as compared to an industry average of 5.5x. In 2013 and 2014, their coverage was close to 15x, three times higher than the industry average. Although these figures show a

7 more than sufficient ability to pay for interest on debt, the questionable change from adds to the downward fall in solvency for this period in time post-golden money acquisition. Profitability Profitability, the ability for a company to retain earnings after covering all expenses, is important to a company because it shows the financial health of a company and the overall financial attractiveness of a company to current and potential shareholders. There is an obvious trend that the company experienced significant change between 2014 and 2015, as shown in the drastic changes in the profitability ratios. Still, do not let this statistic fool you as Hershey is very profitable compared to the industry and its biggest competitor, Nestle. Hershey s Gross Profit Ratio, which compares gross profit to net sales, was consistently in the mid-range at 46% and 45% to 1 from 2013 to This is good because it shows that the company s cost of goods sold and revenue, which make up gross profit, did not change drastically over the three years. It is also good because it shows that Hershey was a leader in the industry on the basis of this ratio, with only Nestle having a higher gross profit ratio at 50% to 1 meaning 50% of their gross profit is from net sales. Hershey s profit margin ratio was a ratio that shows significant change between 2013 and The ratio was 11% to 1 in both 2013 and 2014, but dropped to 70% to 1 in The decrease in 2015 was not large but it is definitely notable, especially after considerable stability in the previous year. The difference was caused by a significant increase in interest expense which resulted in a $300,000 (in millions) decrease in net income. Still, the company has the highest profit margin ratio in the industry, with Nestle trailing at 10% to 1. It is interesting to

8 note that while Nestle has a slightly higher gross profit ratio, their profit margin ratio is slightly lower which shows that the two companies are close competitors in respect to profitability. The return on assets ratio is another ratio that decreased significantly from 2014 to Hershey s profitability in respect to assets only dropped from 18% to 1 to 17% to 1 between 2013 and 2014, but found itself at 11% to 1 in The cause in this case was also due to a large decrease in net income caused by a large increase in interest expenses. Still, Hershey maintains the highest return on assets ratio, with Nestle having only 7%. The industry statistics were calculated without adding interest expense, net of tax which makes a notable difference in the figures. So to make it easier to compare, we will use Hoover s 14% ratio for Hershey which does not include the interest expense. This only makes Hershey appear even stronger with respect to the ROA ratio as it is nearly twice that of Nestle. Hershey s return on sales ratio, the company s ability to generate profit from its revenue, is another ratio that shows a significant change in Hershey s financial standing in After a 13% to 1 ratio in both 2013 and 2014, Hershey s ROS dropped to 8% in This change was caused by an increase in interest expenses and a decrease in net income. With no real source of ROS from the industry, we will compare Hershey s ROS with that of Nestle, their strongest competitor. Nestle also experienced some significant changes in their ROS ratio for the same reason, changes in net income caused by increasing interest expense. Because of this, their ratio went from 11% to 1 in 2013 to 16% in 2014, then back down to 11% in 2014 (Morningstar financials). At this moment, it would be safe to assume that rising interest expense is normal in this industry since the two leading companies in the industry have exhibited it in some capacity.

9 The changes may also show that the two companies engaged in similar financing activities that induces rising interest expenses. Hershey s asset turnover ratio, which measures a company s ability to use its assets to generate revenue, has also experienced a significant change over the past 3 years, mainly rom In that time the ratio dropped from 1.41 to 1 to 1.35 to 1. In 2015, the ratio remains at 1.35 to 1. This means that for every $1 of average assets the company was able to make $1.41 of sales. Nestle, is trailing in this respect as well since its ratio is a mere.69. This shows that Hershey is better able to use its assets to attain sales. Even after significant change in 2014, Hershey still has one of the highest asset turnover ratios in the industry. The return on common stockholder s equity is a measure of importance to stockholders, because it gives context to how well their investments perform compared to other providers of capital to the company. Hershey s ROCSE has decreased 22% from 2013, but has returns substantially higher than the average, with 40% in 2015 compared to an industry standard of 6.5%. This figure is much higher than the return on assets for 2015 at 11%, which shows that Hershey uses borrowed funds effectively. This in conjunction with the debt to equity ratio gives insight into Hershey s unique financial methods. Earnings per share is one of the most common figures used by stockholders, because a per-share basis makes profit more understandable than for the entire company. The EPS for 2015 was $3.13, down a tremendous $1.58 from In 2013, however, EPS was $3.66, which leads us to believe that there was a significant event increasing profitability, despite general stability in other metrics.

10 The price/earnings ratio is an important metric that puts stock price, valuation, and the company s outlook into perspective. Hershey s PE in 2013 was 26.57, falling to in 2014, and finally reached in The industry median is according to Hoover s, so Hershey is outperforming its competitors by a decent margin, whether it be caused by the limited amount of equity available, consistent gross profit, or both. Conclusion After analyzing Hershey s profitability, solvency and liquidity, we have come to the conclusion that although Hershey has seen a significant decrease in liquidity and solvency, they are experiencing an increase in profitability and are financially healthy. The decrease in liquidity and solvency can be attributed to Hershey s use of debt financing to raise money for capital expenditures. This method is evidenced by the return of stockholders equity and the debt-to-equity ratio, which indicate that Hershey uses debt as a way to pay for expenses. It seems that this transition occurred in 2014, as that is when we saw a significant drop in liquidity and solvency. The smaller drop from 2014 to 2015 may have also been due to Hershey s ill-advised purchase of Shanghai Golden Monkey as the company ended up doing poorly. Works Cited "Food Manufacturing." Hoover's. N.p., n.d. Web. 14 Nov Watrous, Monica. "Hershey Troubled in China." Food Business News. Sosland, 10 Aug Web. 5 Dec