As a dividend growth investor, I seek new investment opportunities in income-producing assets. I often add to my existing positions when I find them attractive. I also use market volatility to my advantage by starting new positions to diversify my holdings and increase my dividend income for less capital. I seek new options within sectors I already have exposure to.
The consumer staples sector is attractive, and The Hershey Company (NYSE:HSY) in particular. I have exposure to consumer staples in my portfolio, but as it is a significant segment, I tend to diversify within. Right now, when there is a higher level of uncertainty in the business environment, investing in this sector allows investors to lower the volatility of their portfolios.
I will analyze The Hershey Company using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.
Seeking Alpha’s company overview shows that:
The Hershey Company engages in the manufacture and sale of confectionery products and pantry items in the United States and internationally. The company operates through three segments: North America Confectionery, North America Salty Snacks, and International. It offers chocolate and non-chocolate confectionery products, gum and mint refreshment products, pantry items, such as baking ingredients, toppings, beverages, and sundae syrups, and snack items comprising spreads, bars, snack bites, mixes, popcorn, and pretzels.
The revenues of Hershey have increased by 56% over the last decade. The revenues grow organically as the company uses particular acquisitions to support its supply chains, increase volumes, etc. Since the pandemic, the demand for Hershey’s products increased significantly, and the central part of the growth has been since then. In the future, as seen on Seeking Alpha, the analyst consensus expects Hershey to keep growing sales at an annual rate of ~3.5% in the medium term.
The EPS (earnings per share) of the company during the same decade has increased by 157%. The company has enjoyed EPS growth faster than the sales growth due to the improving margins over that decade, together with the buybacks, which supported income increase on a per share basis. It is a consumer staples company, and the graph below shows how stable the growth is when selling everyday products. In the future, as seen on Seeking Alpha, the analyst consensus expects Hershey to keep growing EPS at an annual rate of ~6.5% in the medium term.
The company has a long track record of increasing its dividend. The company has not reduced the dividend for more than 30 years. Moreover, it has increased yearly over the last thirteen years since the financial crisis. Therefore, investors should have a rather high conviction that there is more room for growth. The dividend yield stands at 1.74% right now, and there is still room for growth as the payout ratio sits at 45%, which means the dividend is relatively safe and unlikely to be cut.
In addition to dividends, the company returns capital to shareholders via buybacks. These share repurchase programs support EPS growth as they lower the number of shares outstanding. Over the last decade, the company has reduced the number of shares by close to 9%. Buybacks are highly effective when the valuation is low. Therefore, if the share price continues to decline, I’d expect the company to be more aggressive with the buybacks.
The P/E (price to earnings) ratio of Hershey stands at 19.72 when using the forecasted EPS for 2023. This is the lowest valuation we have seen over the last twelve months. The company has been trading for almost 30 times earnings back in May, and since then, the valuation has been adjusted. However, paying nearly 20 times for a company growing at a mid-single-digit rate is still somewhat expensive.
The graph below from Fast Graphs also shows that despite the company trading below its average valuation, it is still not attractively valued. The company trades for 20 times earnings compared to an average P/E of 23. However, the growth rate during the last two decades was almost 9% annually, compared to the current 6.5% yearly forecast. Moreover, the higher rates mean investors should expect a decline in the P/E ratio.
Hershey has unique brand power. The Hershey Company boasts an exceptional track record in the consumer goods industry, with a formidable brand presence. With an impressive $10.4 billion net sales, Hershey is a powerhouse, holding the number two position in U.S. Snacking and dominating the number one spot in U.S. Confection. The strength of its brands, including iconic names like Hershey’s, Reese’s, and Kit Kat, provides the company with a unique competitive advantage in the United States, and we saw it with another sales increase during Halloween. This brand power not only ensures customer loyalty but also allows Hershey to command premium pricing.
Scale and diversification are other prominent opportunities. Hershey leverages the benefits of economies of scale through its extensive operations. The company’s broad range of products, including chocolates, candies, and snacks, coupled with its global market presence, provides diversification that minimizes risks associated with market fluctuations. Hershey’s ability to adapt to changing consumer preferences and expand into new markets ensures consistent revenue.
Looking forward, there is an opportunity regarding the company’s conservative balance sheet. Hershey’s financial prudence is a crucial advantage for investors. The company maintains a very conservative balance sheet with a low debt-to-EBITDA ratio of 1.7. This conservative approach not only ensures the company’s financial stability but also leaves room for strategic acquisitions, even in challenging economic times when other companies may see their valuations shrink.
Health concerns and changing consumer habits following the pandemic are a risk. The company deals with the growing concern over health and wellness, especially following the COVID-19 pandemic. As people return to their regular habits, there’s an increasing awareness of the health risks associated with consuming sugary sweets and chocolates. With increased attention to nutrition and well-being, there’s a possibility that consumers may reduce their consumption of sweets. The analysts covering the company are concerned that the shift may cause slower sales growth in the medium term.
Inflation is a concern that impacts many companies, including Hershey. Data from Hershey’s Q3 2023 results indicates that the company has raised the prices by 11.1% across its North American confectionery business, while organic volume slipped 1%. This suggests consumers may resist higher prices for Hershey’s candies and chocolates. Inflation can erode profit margins, and if Hershey continues to raise prices, it may risk losing price-sensitive customers or experiencing reduced demand.
The competition and shifting consumer preferences also risk Hershey. The competitive landscape in the snack industry is constantly evolving. Consumer priorities have shifted towards healthier and more satisfying snack options. There has been a softening in the salty snacks market, with pricing playing a significant role. Consumers are increasingly looking for affordability and value. Moreover, the competition is intensifying not only from traditional confectionery brands but also from innovative and healthier snack options. Hershey must adapt and innovate to stay competitive and meet changing consumer demands.
So, we have seen some softening in Salty Snacks overall. Volumes held fairly steady throughout the quarter. But growth decelerated as pricing lessened. And some growth shifted to non-measured channels. Again, we know that affordability and value are increasingly important to consumers. And we’re also seeing them prioritize some of the more satiating snacks. So, as we look at our business, certainly, we’re seeing a lot of strength in Pretzels in the category as well as our Dot’s distribution opportunities.
(Michele Buck – Chairman and CEO, Q3 2023 Earnings Call)
Hershey is a tremendous blue-chip company with a history spanning over 120 years. The company has solid fundamentals with steady sales and income growth, leading to capital being returned via buybacks and dividends. Moreover, the company has growth opportunities organically using its scale and diversification and inorganically using its strong balance sheet and financing capabilities.
There are risks for the investment thesis in Hershey, especially as demand may be softer and inflation is challenging. However, these are challenges that the company should be able to deal with as it did in the past. However, I am rating the shares a HOLD due to the valuation. Paying almost 20 times for that growth rate when the rates are so high is too high for me. I believe a P/E ratio of 16-17 will be more reasonable.