Trick or Treat? 3 Chocolate Stocks to Watch

Halloween is a time of year when decadent desserts trump calorie counting, and there has been no better time for emotional eating than during the coronavirus pandemic. At least, that's what we tell ourselves, and chocolate is the top "cheat" snack for many people.

No other food item has survived the onslaught of the healthy eating trend quite as well as chocolate. The worldwide chocolate confectionery market was valued at $114.33 billion at the end of 2019 and is projected to reach $136.42 billion by 2027, growing 2.3% annually. A more optimistic projection indicates the global chocolate market is set to reach $171.6 billion by 2026, rising 5.3% annually.

It's hard not to be tempted by the growth prospects of chocolate makers, once they bounce back from the pandemic-led sales decline. Long-term investors looking for a confectionary play may want to look at the following chocolate stocks. With strong fundamentals, product innovation, and bountiful demand from emerging markets, these companies are well positioned to corner the largest slice of the global chocolate market. They are at or above our fair value estimates, so investors may want to wait for a meaningful pullback to create some margin of safety and an attractive entry point.

Hershey HSY Current yield: 2.13% Forward P/E: 23.20 Price: $146.34 Fair Value: $131 Value: 12% Premium Moat: Wide Moat Trend: Stable Morningstar Rating: ★★ Data as of Oct. 23, 2020.

U.S. confectionery behemoth Hershey controls around 45% of the nearly $25 billion domestic chocolate market. The firm owns more than 80 brands, including popular names such Reese's and Kit Kat. Although Hershey's products are sold in about 85 countries (including Brazil, China, India, and Mexico), just 10% of its total sales come from outside the United States.

Under the leadership of CEO Michele Buck, the company has been ramping up investments in its core domestic brands while pulling back international spend, according to Morningstar's equity report. Hershey has seen some sales decline in recent times because people are making fewer trips to convenience and drug stores (the source of a fourth of its sales) and social distancing mandates.

"This has been partially offset by outsize e-commerce gains (where Hershey realized a robust 200% year-over-year sales jump in the second quarter)," writes Morningstar sector director Erin Lash in her report, which also cautions that at just 2% of its sales mix, e-commerce won't materially aid its near-term trajectory.

On a positive note, while the pandemic will damp the all-important Halloween period (which accounts for 10% of the firm's consolidated sales), the remainder of sales in the festive season are less likely to be impacted, adds Lash, pointing to how the firm's resiliency played out during the 2008 economic recession. "With its mix of leading brands and focus on innovation, we don't think Hershey is poised to drop the ball in this key period," writes Lash, who puts the stock's fair value estimate at $131 per share.

Nestle NSRGY Current yield: 2.34% Forward P/E: 24.10 Price: $118.24 Fair value: $103.00 Value: 15% Premium Moat: Wide Moat Trend: Stable Morningstar Rating: ★★ Data as of Oct 23, 2020.

The largest food and beverage manufacturer in the world by sales, Nestle has amassed more than CHF 90 billion ($98 billion) in annual revenue. Its portfolio of global products includes brands such as Nescafe, Perrier, Pure Life, and Purina. The company also owns popular chocolate brands including KitKat, Milkybar, and Aero.

"Nestle boasts a broad portfolio of products across multiple categories and regions, spanning beverages, dairy products, nutrition and healthcare, ready-made meals, confectionery, and pet care--a global market position that is tough for new entrants to match," writes Morningstar equity analyst Ioannis Pontikis in his report.

While Nestle faces competition from small, more agile competitors, its research and development, marketing, and trade spending capabilities ensure that its "products will always be in sync with the latest local consumer trends and easily available wherever consumers are shopping," according to Pontikis.

Nestle's wide Morningstar Economic Moat Rating is underpinned by its entrenched position with retailers and a durable cost edge. "The firm's structural baseline returns are in the mid- to high-teen percentage range, and we anticipate that it will generate excess economic profits for at least the next 20 years," adds Pontikis, who puts the stock's fair value at $100 per ADR.

Mondelez International MDLZ Current yield: 2.07% Forward P/E: 20.58 Price: $56.61 Fair value: $53.00 Value: Fairly valued Moat: Wide Moat Trend: Stable Morningstar Rating: ★★★ Data as of Oct 23, 2020.

Chocolate and snack giant Mondelez owns household brands that include Oreo, Chips Ahoy, Halls, Trident, and Cadbury. The company dominates several product aisles, including biscuits (44% of sales), chocolate (32%), gum and candy (13%), beverage (4%), and cheese and grocery (7%). It generates just over one third of revenue from developing markets.

The confectioner's wide moat stems from strong retail relationships and the vast resources it utilizes to support its portfolio of well-known brands, seven of which generate annual sales of more than $1 billion each. These attributes help drive traffic to retail outlets. "As a leading player in the global snack category, Mondelez has earned a wide economic moat rating resulting from the economies of scale gained from its expansive global network, with nearly three fourths of revenue derived from outside North America," writes Lash in her report.

The snacking giant's dominance is evidenced by its market share in various areas. "Mondelez holds the top spot in the sweet biscuits category (with a 15.0% share of the worldwide space, according to Euromonitor) and is the second-leading global sugar candy manufacturer (with a 2.4% share, primarily as Halls is the second-largest candy brand worldwide)," points out Lash, who puts the stock's fair value at $53.