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Hershey's Market-Beating Yield Attracts Conservative Investors

GuruFocus.com
·7 min read

Shares of the Hershey Company (NYSE:HSY) have declined almost 14% year-to-date against less than a 3% decline in the S&P 500. The consumer staples company likely won't attract many growth orientated investors, though I think it should due to its improvements in earnings and profit margins.

Moreso than growth, income investors might be interested in the company's long history of paying dividends. Shares now trade more in line with their long-term average dividend and valuation than in recent history.


Company background and recent earnings results

Hershey has been in business since the late 1800s and has grown over time to become the largest producer of chocolate and nonchocolate confectionery items in the U.S. The company's top selling brands include Hersey's, Reese's, Cadbury, Twizzlers, Ice Breakers and Jolly Rancher. The majority of sales come from the U.S., with just 7% coming from international markets.

Hershey reported its first-quarter earnings results on April 23. Revenue for the first quarter increased 1% year-over-year to $2 billion, which missed Wall Street's estimates by less than $50 million. Earnings per share increased 2.5% but came up 8 cents short of expectations. Hershey has generally been good at growing its top and bottom-lines. The company hasn't posted a year-over-year decline in revenue or earnings per share since the fourth quarter of 2017.

Organic sales for the quarter edged up 0.5%. Hershey's purchase of ONE Brands and its lineup of "better-for-you" snack bars in September of 2019 added 0.8% to revenue results during the quarter. Currency exchange was a 0.3% drag during the quarter. Hershey was able to increase prices by 2.8%, though volumes fell 2.3%.

North America sales improved 2.1% from the prior year as price realization added 2.9% and acquisitions contributed 0.9%. These gains were partially offset by a 1.7% drop in volumes. Despite the headwinds, the company's retail takeaway increased 5.9%, which drove 100 basis points of market share gains. Expenses increased 6.9% for the quarter on account of higher advertising expenses.

The International business declined 8.1%. Foreign currency exchange reduced revenue results by 2.3% and volumes declined 7.2%. Net price increases contributed 1.4% to growth. Hershey's focus markets, which include Mexico, Brazil, India and China, were especially weak, declining 13.1% with organic sales dropping 8.4%. Within this group, China sales were lower by nearly 47% as demand for products dried up during the government mandated lockdown of key markets.

Adjusted gross margins improved 180 basis points to 46.6% due to a combination of higher prices and plant efficiencies from building inventory prior to the Covid-19 pandemic. The company also bought back $150 million worth of stock in the first quarter.

Hershey had expected to earn $6.13 to $6.24 per share in 2020, consistent with its long-term projected EPS growth rate of 6% to 8%, but the company pulled this guidance due to uncertainty.

Hershey has managed to compounded EPS at an annual rate of 8.5% from 2010 through 2019. The company reduced its share count by nearly 1% over the last decade. At the same time, the net profit has more than doubled, which equates to a CAGR of 7.6% Sales have only increased 3.5% annually, so Hershey has vastly improved its ability to create profit. Remarkably, the net profit margin has increased every year from 2010 (10.4%) through 2019 (15.3%). Not bad for a member of the consumer staple sector.

The company's balance sheet also looks solid. At the end of the first quarter, Hershey had $2.9 billion in current assets, including $1.1 billion of cash and equivalents against total debt of $5.3 billion. However, just $1.6 billion of this debt is due in the next 12 months.

The ability to consistently grow revenue and earnings has been a hallmark of Hershey's business. The ability to stay in business for nearly 130 years shows that the company is able to provide consumers with products that they enjoy. These two factors should be attractive to investors looking for more stability from the stocks they own.

Dividend and valuation analysis

Hershey has distributed a dividend for 361 consecutive quarters, giving the company a long track record of payments. After pausing its dividend growth in 2009, Hershey has raised its dividend for the past 10 years.

The company has an average dividend growth rate of:

  • 7.6% per year for the past three years.

  • 7.9% per year for the past five years.

  • 9.7% per year for the past 10 years.



Hershey raised its dividend by 7.1% for the Sept. 16, 2019 payment. This raise is just under the three and five-year growth rates. Shareholders should know the size of their next dividend raise sometime in late July if the company sticks to its usual declaration timeframe.

Shares of Hershey have an annualized dividend of $3.09, giving the stock a 2.4% dividend yield as of the most recent close. This matches the 10-year average yield and is 50 basis points higher than the 1.9% average yield of the S&P 500.

Analysts expect the company to earn $5.78 per share for full-year 2020. Using the current annualized dividend, the earnings payout ratio is 53% for 2020. Hershey's long-term dividend payout ratio has been quite consistent over the last decade. The ratio has fluctuated in a range of 48% to 54% over this time span for an average payout ratio of 51%. This consistent payout ratio means that Hershey has been very successful at managing its business and its dividend growth to ensure that payments were increased every year.

Free cash flow shows nearly the same level of safety, outside of the most recent quarter. Hershey distributed $169 million of dividends in the first quarter of the year while generating just $147 million of free cash flow for a free cash flow payout ratio of 115%.

Longer-term, the free cash flow payout ratio looks much healthier. Hershey paid out $610 million of dividends last year and produced $1.45 billion of free cash flow for a payout ratio of 42%. The average payout ratio from 2016 through 2018 was 53%. This leads me to believe that the first quarter looks like it is more of the exception than the rule when it comes to the free cash flow payout ratio.

Shares of Hershey closed Thursday's trading session at $126.75. This gives the stock a forward price-earnings ratio of 21.9. This is identical to the stock's five-year average price-earnings ratio and just above the 10-year average multiple of 21.7.

Given the current and historical valuations of the stock, Hershey appears to be fairly valued. The dividend, despite the free cash flow payout ratio in the first quarter, looks safe and protected from my view.

Final thoughts

Hershey is the largest chocolate and nonchocolate confectionery producer in the U.S. and has some of the top selling candy bars in the market place. The company has also made acquisitions in order to meet consumers' changing habits.

The first quarter results were somewhat lower than expected, but still represented growth from the previous year. Hershey's balance sheet is solid and the company has greatly improved its ability to translate sales into profits over the long-term.

Hershey has long paid a dividend and has been fairly consistent in its average raises over the last five years. With a safe dividend that offers more income than the S&P 500 but with a cheaper valuation, I think Hershey would be a good addition to a conservative investor's portfolio.

Author disclosure: the author has no position in any stocks mentioned in this article.

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This article first appeared on GuruFocus.