Hershey: Sweet Buy With An Even Sweeter Yield

Summary

• From both an investment and business standpoint, confectionery giant The Hershey Company offers great investment appeal.
• Hershey displays a number of competitive advantages.
• Hershey is moderately valued, eliciting a buy recommendation.

Source: Google Images "The Hershey Company"

The Hershey Company (NYSE:HSY) displays strong investment appeal as a result of the company's formidable business characteristics and strong capital appreciation/dividend performance. HSY displays a sizable 2.87% dividend yield and has sustained consistent dividend growth for the past 8 years. HSY's positioning in the confectionary industry makes the stock inherently defensive as consumer staples experience steady demand in spite of vagaries in the economic cycle. Overall, HSY's defensive characteristics, business health, strong growth prospects, and investment appeal make the stock a portfolio essential.

Why Buy the Hershey Company

Business Strengths: From an overall business standpoint, HSY displays formidable business advantages. The company has prominent brands, capable management, and intrinsic business advantages. HSY is one of the most widely recognized candy manufacturers. In the United States, HSY is the largest player in the confectionery market, assuming 31.1% of U.S confectionery market share. The only competitors that come close to HSY's market share are Mars at 28.9%, Mondelez at 5.1%, Lindt/Ghirardelli 5.2%, and Nestle at 4.3%. HSY's enormous business size enables the company to fully capitalize on economies of scale through extensive mechanization, large material buying, and sizable capital deployments. Such business qualities help HSY precipitate healthy bottom line figures (gross margin of 46% and profit margin of 11%). HSY also offers some of the most prominent candy brands ranging from Reese's, Hershey Bars, Kit Kat, Almond Joy, Hershey Kisses, Twizzlers, and Jolly Ranchers.

Source: Google Images

In addition to HSY's candy segment, the company is also involved in gum and mint products (ex. Ice Breakers, Breathsavers, and Bubble Yum), pantry and snack items (baking products, toppings, syrups, chocolate spreads), high end chocolates (Scharffen Berger, Dagoba brands), and beef jerky snack products (Krave). HSY's diversification across various segments offers broadened customer appeal, assuring a candy or snack option for various taste preferences. HSY (although deriving 88% of revenues from the North American market) is involved in global operations affording future growth opportunities. Furthermore, HSY product popularity garnishes greater negotiating power with retailers and the company's diversification beyond the confectionery market and into the snack food business caters to healthier consumer eating preferences. From an overarching perspective, HSY demonstrates strong business characteristics as a result of the company's low number of competitors, sizable business moat, extensive product offering, and dominant position in the U.S market.

Defensiveness: Fundamentally, HSY's positioning in the chocolate industry makes the stock inherently defensive. Chocolate and sugar have gradually evolved from a pleasant indulgence to a consumer dietary staple in 21st Century America. The U.S chocolate confectionery segment has sustained consistent year over year revenue increases. As it currently stands, revenue from the chocolate confectionery market alone has accumulated to $29.5 billion. HSY is a market leader in the North American chocolate sales market, monopolizing 44.6% of total revenues derived from chocolate sales. As a result of the company's large market share, HSY is well-positioned to capitalize on population growth and elevated chocolate consumption.

Source: Statista U.S Chocolate Confectionary Total Revenues

From a fundamental business perspective, HSY is well-positioned. The company's snack and sugar products are readily demanded in the North American market; HSY has sustained continued revenue increases for decades. The chocolate business affords high margins due to low production costs. HSY maintains the most preeminent chocolate brands and even though Hershey has experienced gradually increasing top line revenues, the company can continue to precipitate growth through acquisitions.

Dividend/Economic Versatility: HSY offers an attractive dividend yield of 2.87%. HSY's dividend yield is set at a moderate payout ratio of 49.1%, implying dividends are sustainable, and HSY's has exhibited an enduring commitment to investors: consistently increasing the dividend yield, particularly during economic downturns ex. 2000, 2007-2008, and 2016. Furthermore, HSY displays strong economic versatility. Even during financial downturns HSY displayed consistently increasing revenues.

HSY Dividend Yield (TTM) data by YCharts

HSY Revenue (Annual) data by YCharts

Financial Assessment

Balance Sheet: Despite HSY's business advantages, the company displays a poor balance sheet. HSY demonstrates low liquidity (short-term liquidity levels have hovered around $300-$400 million and HSY has historically not maintained any long-term investment cash reserves). However, something of even greater concern is HSY's problems with long-term debt escalation. Over the past five years, HSY's debt levels have skyrocketed by 147% from close to $1.9 billion in 2013 to present levels of $4.6 billion. Although HSY's long-term debt is well covered by operating cash flow (29.7% coverage), HSY has striven to drive growth inorganically through acquisitions which has the undesired effect of elevating debt levels. Already HSY's debt of $4.6 billion renders a debt to asset ratio of 0.84, which is unfavorable from a risk perspective. Additionally, HSY will be confronted with the U.S's rising interest rate environment.

Income Statement: HSY displays a good income statement. The company has experienced increasing top line and bottom line revenues: net income, total revenues, and operating income have increased over the past number of years. Also, HSY's revenue costs have flatlined and SGA expenses have fallen. HSY has delivered strong performance across a number of metrics; the company boasts an industry-beating return on equity of 102%, 15% return on assets, and 42% return on invested capital. Acquisitions and increased product offerings offer solidified growth prospects in HSY's North American market, and despite international sales difficulties, I anticipate future long-term growth into untapped global markets.

Source: Hershey 2017 Investor Presentation

Valuation: HSY is fairly valued. Although HSY exhibits a high price to book ratio of 19.32, the company's PEG ratio of .29 is low (less than one), the PE ratio is reasonable at 18, and HSY is slightly undervalued based on future cash flows. HSY's current share price of $89.54 is below the future cash flow value of $92.76. HSY is also nearing a 52-week low of $89.15

HSY Price to Book Value data by YCharts

Conclusion

I would grant HSY a buy rating. Although HSY displays vulnerabilities in long-term debt accumulation, HSY's debt is well-covered, and the company displays a variety of attractive investment characteristics. HSY offers a great dividend yield of 2.87%, good capital appreciation, a formidable brand/product line, and distinct business cost advantages. HSY also has a low number of competitors, boasts substantial market share in its various snack and confectionary product lines, and the company offers defensiveness throughout vagaries in the economic cycle. HSY remains a great portfolio holding for the defensive investor and is currently an even more enticing buy as a result of the stock's moderate valuation.

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Analyst’s Disclosure: I am/we are long HSY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Data is for illustrative purposes only. The accuracy of the data cannot be guaranteed. Narrative and analytics are not tailored to individual portfolio needs or investment objectives. The presentation of a given security is based on my own model portfolio, which is presented solely for educational purposes. Yanni Lodato is an individual investor and author, not an investment adviser. Readers should always engage in further research and consider (as appropriate) consulting a fee-only certified financial planner, licensed discount broker/dealer, flat fee registered investment adviser, certified public accountant, or qualified attorney before making any investment decisions.