Hershey: Sweet Dividend Increases, Sour Equity Growth Rate

Company Profile:

From Yahoo Finance

The Hershey Company engages in the manufacture, marketing, distribution, and sale of various types of chocolate and confectionery, refreshment and snack products, and food and beverage enhancers in the United States and internationally. Its chocolate and confectionery products include chocolate bars, drinking cocoa mixes, dark chocolate products, candy bars, handcrafted chocolate gifts, and organic chocolate products. The company’s snack products comprise cookies; rice, marshmallow, and granola bars; macadamia snack nuts; and chocolate cocoa peanuts and almonds, and trail mix. It offers refreshment products in the form of mints and chewing gum; and food and beverage enhancers in the form of baking ingredients, peanut butter, toppings, and beverages.

Market capitalization of $10.62B.

Company Fundamentals:

Starting with the return on invested capital, I can see that management has done an amazing job. The ROIC has been on an increasing trend over the last 10 years from the high teens right up into the low 30s. The 5 year average ROIC is 24.8% and over the last 3 years, the ROIC has consistently hung around 30%.

Return on equity is even better; the 10 year average ROE is 40.35% and the 5 year average ROE is 49.51%. Now, Hershey’s has a lot of debt. Total debt makes up 79.5% of their capital. But they have been able to leverage this debt effectively.

And now we hit our first stumbling block. The equity growth rate has been absolutely atrocious over the last 10 years! The 9 year average rate is a mere 1.32%, and that is as good as it gets! Over 5 years, the equity growth rate has been -6.73%. The 3 year growth rate is -14.51%. And last year’s growth rate was a whopping -30.08%! This stock seems to be going backwards!

But wait. The EPS growth rate does not show the same trend. In fact, the EPS growth rate isn’t half bad. The 9 year average is 10.33%. The 5 year rate is better at 12.01%. The 3 year rate drops to 9.8%, and last year’s EPS growth rate was 3.95%.

So although the earnings have been growing, the company’s book value has been decreasing. Is it function of their large debt?

Sales growth rates are pretty low. Over the 10 year period, the growth rate has been 1.38%. Over 5 years, it has been 2.74%. Last year’s sales growth rate was 2.24%. So you can see that sales growth is extremely limited.

Dividend Fundamentals:

Hershey’s has a dividend yield of 2.29%. That is slightly higher than the S&P 500 Index dividend yield of 1.98% and exactly matches the dividend yield of the DJIA. I would consider this an average dividend yield.

The dividend growth rate has been above average in my opinion. The 9 year average dividend growth rate is 10.53%. It improves to 12.65% over the last 5 years. Last year’s dividend growth rate was 10.75%. We see consistent, above average dividend increases.

The payout ratio has stayed pretty flat over the 10 year period increasing from 37.67% to 43.46%.

And considering the almost non-existent sales growth rates, Hershey’s has been able to increase their cash flows. The 9 year average cash flow growth rate is 8.79%. It is 10.09% over the last 5 years. However, last year’s growth rate was a mere 2%.

Valuation Models:

Let’s calculate our model prices using my 3 techniques for valuing a dividend yielding stock.

From a dividend yield perspective, Hershey’s current yield of 2.29% is high. Interestingly enough, both the 10 year average high dividend yield and the 5 year average high dividend yield are 2.15%. So if I demand 2.15% as my minimum yield, then I should not pay more than $50.19. At today’s current price of $47.10, it would seem that Hershey’s is selling at a 6.15% discount.

However, Mr. Benjamin Graham would vehemently disagree. His Graham number works out to $12.45. That would imply that Mr. Graham thinks that a 278% premium exists today!

Evaluating Hershey’s with my discounted present value method was near impossible. Why? The reason is that I use the historical equity growth rates to determine a future EPS growth rate. And if you remember, the only positive equity growth rate was the 9 year average at 1.32%. Well, with a future EPS growth rate that low, then as an investor, I would not want a P/E any higher than 2 times the future EPS growth rate or 2.64. Needless to say, with that low a growth rate and P/E, this stock worked out to be selling at a premium of almost 2000%!

Now, analysts have forecast a future EPS growth rate of 9.20%. And this does look like a reasonable EPS growth rate from looking at the historical EPS growth rates. But my system uses the equity growth rate and I will stick with it.

See my HSY calculations here.

Here is the 1 year stock price chart:

As you can see, Hershey’s has had quite the drop since hitting a high back in April 2007.

Conclusion:

Although Hershey’s has done a good job increasing their dividends over the last 10 years and has maintained a fairly conservative dividend payout ratio, I just can’t get over the equity growth rates. As an investor, I just do not want to see the book value per share decreasing each and every year. If I remember correctly, Warren Buffett said that an increasing book value per share was one of the most important trends to look at.

I would not include HSY in a superior dividend yielding portfolio.

Full Disclosure: I do not own any shares in HSY.

Comments

[Paul Meisel:]

I am waiting for the other shoe to drop -- if ROIC and earnings are good, why doesn't book value follow? Is there something unusual going on in the structure of their debt, fixed assets, or some other category? Are they living off an aging fixed asset base?

2007 Aug 15 12:33 PM