GOLDMAN: Long Chocolate, Short Soda-Pop

Chocolate Cake

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The pair trade of the day definitely goes to Goldman analyst Judy Hong, who goes long Hershey’s, and short Doctor Pepper:No longer what the Doctor ordered; downgrade DPS to Sell
We see DPS shares underperforming our Food/Beverage/Tobacco universe: (1) Commodity inflation is likely to be worse than expected. We expect COGS inflation to be at least at the high-end of management guidance of +6%-7% and for the recent increase in fuel costs to present an incremental cost headwind; (2) Competition is heating up in soda in 2011 with both KO and PEP stepping up on colas and flavored sodas, which poses risk to DPS’ market share, (3) We see risk to consensus profit expectations in 1H11 where we are 3% below consensus. We are lowering estimates 3% in 2011. Consensus may have not factored in higher costs and DPS’s front-end loaded marketing spending; and (4) We believe valuation is full relative to peers with DPS shares at 15x 2011 P/E (ex $0.22 in non-cash deferred revenue), or at parity with PEP. We are lowering our 12-month price target by $1 to $37 on our lower EPS, which implies flattish total return potential. We could get more constructive if commodity costs decelerate, pricing is better and/or share gains accelerate.

A sweeter outlook for HSY; upgrade to Neutral from Sell
We upgrade HSY to Neutral from Sell, as we no longer see downside risk to consensus estimates. We raised our EPS estimates last week after HSY followed its competitors’ lead in raising prices. We now see 10% EPS growth this year and next versus guidance of +6%-8%. We also expect an increase to its share repurchase authorization in the next few months. We believe downside to HSY’s share price and valuation is limited given these factors and attractive fundamentals (innovation and pricing power in chocolates). That said, expectations are lofty, which could limit upside in shares. We raise our 12-month price target to $59, from $51, reflecting 6% price appreciation potential. Our price target assumes a 19X P/E (up from 16X) and implies 10.7X EV/EBITDA. HSY shares are +52% since being added to the Sell list on January 26, 2010 vs the S&P 500 up 22%.