Hershey Company (NYSE:HSY) continues to churn out iconic brands that add diversity to its classic Hershey and Reese’s chocolate brands. In addition, the company has adapted as consumers are looking for healthier snack options without all the sugar. You'll still find their other candy and gum brands doing well, like Kit Kat, Jolly Rancher, and Ice Breakers. But other snacks like SkinnyPop and Pirate's Booty have continued to expand the revenue sources.
With over 125 years in business and solid fundamentals, Hershey Company will undoubtably remain a solid investment for the future. After a stellar 40% gain over the past year and positive sentiment surrounding the company, many investors are jumping on the bandwagon to invest in this iconic brand.
In this article, we will closely examine the company to see if the fundamentals support continued stability and growth. In addition, we’ll do a valuation analysis to determine if the stock’s current price matches its real value.
When making split-second decisions on the condition and stability of a company, I like to use the BTMA Stock Analyzer company rating score. For The Hershey Company, the BTMA Stock Analyzer shows a score of 85/100. With this score, Hershey is considered to be a good company to invest in, as anything over 70 is a good company score. HSY has high scores for 10-Year Price Per Share, ROE, Earnings per share, Ability to Recover from a Market Crash or Downturn, ROIC and Gross Margin Percent. It has a low score for PEG Ratio. Because of HSY’s low PEG Ratio, it may be an indication that the company has not experienced high growth consistently over the past 5 years. However, Hershey is a relatively old company, and high, rapid growth is not expected in a company that has publicly traded for nearly 100 years. In summary, these findings show us that HSY seems to have above average fundamentals since nearly all of the important financial categories produce great scores.
Before jumping to conclusions, we’ll have to look closer into individual categories to see what’s going on.
(Source: BTMA Stock Analyzer)
Let’s examine the price per share history first. In the chart below, we can see that price per share has been mostly consistent in increasing over the last 10 years, with the exception of 2018 where the share price declined slightly. Overall, share price average has grown by about 160% over the past 10 years or a Compound Annual Growth Rate of 11.32%. This return shows promise since it is slightly higher than the typical long-term S&P 500 return.
(Source: BTMA Stock Analyzer – Price Per Share History)
Looking closer at earnings history, we see that earnings have grown somewhat consistently over the past 10 years, with one deviation. The earnings grew steadily from 2009 to 2014, then a large drop in growth in 2015. Since that drop, earnings have continued to grow, hitting new highs in 2018 and 2019.
Consistent earnings growth makes it easier to accurately estimate the future growth and value of a company. Based on earnings growth, HSY is a good candidate of a stock to accurately estimate future growth or current value.
(Source: BTMA Stock Analyzer – EPS History)
Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors, like the gross margins, return on equity, and return on invested capital.
The return on equity (ROE) for HSY has been quite excellent for the past several years, and has been rising every year since 2015. Hershey’s positive ROE is an indicator that the company is capable of turning assets and cash flow into tangible profits. HSY’s 5-year average ROE is very good at around 74%. For ROE, I look for a 5-year average of 16% or more, so HSY more than surpasses my requirement.
(Source: BTMA Stock Analyzer – ROE History)
Let’s compare the ROE of this company to its industry. The average ROE of 88 Food Processing companies is 1.90%.
Hershey’s 5-year average of 74.346% and current ROE of 101.77% are in a league of their own when compared to the industry average.
Like Hershey’s ROE, its return on invested capital (ROIC) followed an almost identical trajectory, and has been on the up and up since 2015. 5-year average ROIC looks positive at 22%. For return on invested capital, I also look for a 5-year average of 16% or more, and HSY easily passes this test as well.
(Source: BTMA Stock Analyzer – Return on Invested Capital History)
The gross margin percent (GMP) for HSY has been quite positive in the last few years, rising from a low in 2016 and hitting new peaks in 2018 and 2019. HSY’s 5-year GMP is strong at 44.98%. I typically look for companies with gross margin percent consistently above 30%. With an above average GMP HSY, is showing that it has the ability to maintain acceptable margins over a long period. A high GMP is an indication that the sale price of a company’s services or goods is generating a strong profit.
(Source: BTMA Stock Analyzer – Gross Margin Percent History)
Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is greater than 1. This is typically a bad indicator, telling us that the company owes more than it owns.
HSY’s Current Ratio of 0.8 is unsatisfactory, indicating that it doesn't have a good ability to use its assets to pay its short-term debt. Ideally, we like to see a Current Ratio of more than 1, so HSY does not meet this criteria.
Overall, based on the balance sheet, the company is showing some red flags and if I were considering to invest in HSY, then I would take time to understand why Hershey is taking on this amount of debt and whether it’s good debt or bad debt. Also, I’d be looking to see if the debt pattern was getting worse or improving.
From looking closer at the balance sheet, it shows that both Current Liabilities and Non-Current Liabilities have been increasing (getting worse) over the past five years.
Another way to see if Hershey's debt level is reasonable is to see if its Earnings Before Interest and Taxes (EBIT) is at least 3x its interest payments. HSY's EBIT to Interest Payment ratio is around 15.25x (way more than 3x), therefore, the company could be considered as being reasonably leveraged.
The Price-Earnings Ratio of 24.2 indicates that HSY might be selling at a somewhat high price when comparing HSY’s PE Ratio to a long-term market average PE Ratio of 15. The 10-year and 5-year average PE Ratio of HSY has typically been between 27 and 28.6, so this indicates that HSY could be currently trading at a low price when comparing to HSY’s average historical PE Ratio range.
HSY currently pays a dividend of 2.11% (or 2.04% over the last 12 months).
(Source: BTMA Stock Analyzer – Misc. Fundamentals)
In regards to dividend history, I’m first interested in knowing if the payout ratio is sustainable. At this time it’s around 48%, which means that there is still room to grow the dividend. Also notice that HSY has a regular history of buying back shares, which contributes to higher payout ratios.
If we look only at the dividend yield, we see a range of 2.02% to 2.57%. This stock pays out a moderate dividend. Dividend payouts have increased consistently, but more importantly, dividend yields have decreased over the 5-year period. This could deter some serious dividend investors from adding HSY to their portfolio.
Although HSY participates in share buybacks, sometimes buybacks don’t make sense, as according to Warren Buffett: “There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds - cash plus sensible borrowing capacity - beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”
When we examined HSY’s balance sheet, we noticed some red flags with its debt-to-equity and current ratio. It seems that HSY doesn’t have much cash when compared with short-term debt. On the other hand, the company had an adequate amount of EBIT when compared to interest payments. So this indicates a sensible borrowing capacity.
Now, to see if the buyback timing made sense. Hershey seems to routinely buy back about the same amount of stocks each year. Hence it appears that the company does not have a strategic plan for making advantageous buybacks.
If I were currently interested in buying HSY now for the dividend, I would be trying to buy when the dividend yield was highest relative to its past. From the chart below, we can see that the dividend yield is near a somewhat low point relative to the past 10 years. Therefore, it’s not an ideal time to buy now if my priority is a better than average return through dividends.
Overall, the dividend situation with HSY is worse than average. On the positive side, the stock pays a moderate and consistent dividend. The dividend payout has been increasing over the years, but the yield has not. Other cons are that buybacks are not performed at opportune times, the company is low on cash when comparing to short-term debt, and the dividend yield is at a low point when compared with the past 10 years.
This analysis wouldn’t be complete without considering the value of the company vs. share price.
For valuation purposes, I will be using a conservative 5.58. I’ve used various past averages of growth rates and PE Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.
In the table below, you can see the different scenarios and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.
(Source: Wealth Builders Club)
According to this valuation analysis, HSY is fairly priced.
This analysis shows an average valuation of around $149 per share versus its current price of about $148, and this would indicate that Hershey Company is fairly priced.
From looking at the facts, Hershey Co. has some warning flags in regards to the balance sheet and its debt. But according to its EBIT to interest payments it seems to be sensibly leveraged. Despite this, the company’s financial situation could be improved overall.
Other major fundamentals are strong, including Earnings and Gross Margin Percent. ROE and ROIC are quite impressive.
The dividend situation is below average as dividend yields haven’t increased consistently and the yield is at a low point when compared to the past 10 years.
Lastly, this analysis shows that the stock is fairly priced.
Another pro is that this stock typically is not affected so sharply during recessions or economic downturns as the general market (S&P 500). This could be since people still tend to buy the company’s beloved low-price item snacks whether times or good or bad. Some would argue that when times are bad, the stress might even cause you to snack on your favorite chocolates even more. Below, we can see how HSY performed against the S&P 500 during the economic crisis of 2008 and years onward. You can see that HSY didn’t decline as much, or as sharply as the S&P 500 during 2008/2009 and it experienced more growth in the years that followed the recession.
“Over the next five years, the analysts that follow this company are expecting it to grow earnings at an average annual rate of 7%. This year, analysts are forecasting earnings increase of 6.83% over last year. Analysts expect earnings growth next year of 7.06% over this year's forecasted earnings.” (Source: Forecast Earnings Growth)
If you invest today, with analysts’ forecasts, you might expect about 7% growth per year. Plus we’ll add the current 2.11% forward dividend. This brings the annual return to around 9.11%.
Here is an alternative scenario based on HSY’s past earnings growth. During the past 10 and 5-year periods, the average EPS growth rate was about 11.3% and 8.1%, respectively. Plus the average 5-year dividend yield was about 2.36%. So we’re at a total return of 13.66% to 10.46%.
Therefore, from these calculations, our annual return could likely be around 9%-12%.
If considering actual past results of Hershey Co., which includes affected share prices, and long-term dividend yields, the story is a bit different. Here are the actual 10 and 5-year return results.
10-Year Return Results if Invested in HSY:
Initial Investment Date: 1/12/2010
End Date: 1/12/2020
Cost per Share: $37.75
End Date Price: $148.13
Total Dividends Received: $21
Total Return: 348.03%
Compound Annualized Growth Rate: 16%
5-Year Return Results if Invested in HSY:
Initial Investment Date: 1/12/2015
End Date: 1/12/2020
Cost per Share: $105.43
End Date Price: $148.13
Total Dividends Received: $12.93
Total Return: 52.76%
Compound Annualized Growth Rate: 9%
From these scenarios, we have produced results from 9% to 16%. I feel that if you’re a long-term patient investor and believer in Hershey, you could expect HSY to provide you with around at least 9% annual return with potential annual returns of 12% if you buy and sell at opportune times. The company seems like it will be a safe investment for the foreseeable future, but it isn’t the best stock for growth or for long-term dividend investors.
As a comparison, the S&P 500’s average return from 1928–2014 is about 10%. So in a typical scenario with HSY, you could expect to earn a similar long-term return result as compared with an S&P 500 index fund.
For me, the choice is certain. I would take an objective look at this company and realize that Hershey Company is a chance to own a solid company supported by exceptional long-term fundamentals with customers that adore its brands. Hershey continually gets ranked as one of America’s most loved products according to consumers, parents, and kids.
The company has proven that it can adapt to what consumers want, while continuing to sell its staple brands. The debt situation could use improvement, but debt comes cheap and is readily available for a company of this caliber, so it’s not a major concern. The dividend situation is not ideal, but the company is continuously returning money back to its shareholders. Finally, it offers a long-term return that’s comparable with the S&P 500 and sometimes exceeds it. I would gladly buy this wonderful company but not at current prices as my valuation analysis tells me that it’s about fairly priced. After a 40% gain over the past year and the market being so overpriced, I’ll wait for things to cool down before I buy this sweet stock.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.