Contents
Summary
- HSY recently released Q3 2018 results and warned its profits will come under pressure given rising costs.
- Higher costs will likely persist into 2019 but there are plans to offset these higher costs with strategic price increases on roughly a fifth of HSY products.
- HSY shares are more suited for investors seeking to avoid significant stock price volatility and who desire a relatively safe dividend where the pace of growth will likely continue to exceed the rate of inflation.
- I currently view HSY shares as overvalued.
Introduction
I have owned shares in The Hershey Company (NYSE: HSY) in an undisclosed Registered Retirement Savings Plan (RRSP) account since just immediately subsequent to HSY’s last stock split which occurred June 15, 2004.
I have covered HSY in the following previous articles:
Hershey Stock Analysis – Boring Can Be Sexy – February 5, 2017
Hershey – There Are Far Better Investment Options Out There – February 5, 2018
Hershey – Beaten Down….Sweet! – June 6, 2018
Now that HSY has released its Q3 results on October 25, 2018 I thought I would have a quick look at management’s outlook for the remainder of the current fiscal year and how the company has recently performed.
At the time of my February 5, 2018 article, HSY had just pulled back to ~$103 from a high of ~$114 at the beginning of January 2018. In that article I indicated:
‘There is a vast universe of publicly traded companies in which you can invest and many offer far more upside than HSY. While we have owned HSY for many years and have been aptly rewarded, I think you will be challenged to generate a decent return if you invest in HSY at current levels (even with the recent pullback).’
Subsequent to that article, HSY retraced to the ~$90 level and I viewed the shares as attractive. In my June 6th article I concluded by saying:
‘I currently have several hundred HSY shares in one of our retirement accounts with a sub $50 average cost and view my current position to be a ‘full position’. As a result, I will not be acquiring additional shares other than through the automatic reinvestment of the quarterly dividends. If this were not the case, however, I would definitely acquire HSY shares at the current market price.’
In this article I take a quick look at how HSY has performed subsequent to my June 6th article and provide my opinion as to whether this is an opportune time for conservative investors to acquire HSY shares.
Before moving on to my HSY analysis here are some pictures I took when I visited the Hershey museum; I visited the museum when I travelled to Hershey, Pennsylvania to participate in the 7th Annual March For The Fallen (see here and here) in late September 2018.
I was fascinated to learn a great deal more about the company’s evolution and in particular the extent of HSY’s operations in Cuba; HSY exited Cuba in 1946 when it sold its operations to the Cuban Atlantic Sugar Company.
Q4 2018 Results
On October 17th, HSY announced that it had finalized the acquisition of Pirate Brands from B&G Foods, Inc., including the Pirate’s Booty, Smart Puffs and Original Tings brands, for a purchase price of $0.42B, or ~$0.36B net of tax benefits.
On October 25th, HSY released its Q3 2018 results and refined its 2018 outlook.
HSY announced mixed Q3 results warned its profits will come under pressure given rising costs.
HSY’s shares came under pressure following the earnings release given concerns that HSY’s adjusted gross margin declined 130 bps YoY from 45.3% to 44%. That figure, however, was in line with management's expectations and was largely attributed to higher freight and logistics costs.
HSY has indicated these higher costs will likely persist into 2019 but there are plans to offset these higher costs with strategic price increases on roughly a fifth of HSY products. Management also expects the newly acquired Pirate Brands to boost growth and profits as these are higher-margin snacking products.
Management reiterated its guidance for full-year revenue to increase 3.5% - 5.5% on the basis of organic net sales growth toward the lower end of its ~2% range.
Looking at HSY’s Q3 2018 Balance Sheet we see a surge in Goodwill and Other Intangibles subsequent to FYE2017. This is attributed to the closing of the Amplify Snacks Brands acquisition on January 31, 2018 and the very recent Pirate Brands acquisition.
The increase in long-term debt is related to the Amplify acquisition (May 3, 2018 Press Release).
The surge in short-term debt is related to the Pirate Brands acquisition. I fully anticipate that a significant proportion of this short-term debt incurred for this acquisition will be converted to long-term debt before the end of the current fiscal year.
FY2018 Projections and Valuation
HSY’s FY2018 projected adjusted EPS range of $5.33 - $5.43 ($5.38 mid-point) has not changed subsequent to being announced when Q4 2017 results were released February 1, 2018.
Its projected diluted EPS range, however, has changes as follows:
- FY2018 Projections announced end of Q4 2017: $4.71 - $4.96: Mid-point $4.84
- FY2018 Projections announced end of Q1 2018: $4.73 - $4.98: Mid-point $4.86
- FY2018 Projections announced end of Q2 2018: $4.76 - $4.96: Mid-point $4.86
- FY2018 Projections announced end of Q3 2018: $4.82 - $4.97: Mid-point $4.90
In my February 5, 2018 article in which I analyzed HSY’s FY2017 results using HSY’s then current ~$103 stock price, I wrote that on the basis of FY2017’s $3.66 diluted EPS and $4.76 adjusted diluted EPS, HSY had a ~28.1 diluted PE and a ~21.64 adjusted diluted PE.
In addition, using the ~$103 stock price and the mid-point of management’s projected diluted EPS ($4.84) and projected adjusted diluted EPS ($5.38), HSY had a ~21.3 forward diluted PE and a ~19.15 forward adjusted diluted PE.
When I wrote my June 6th article, however, HSY was really beaten down and attractively valued. At the time of that article HSY was trading at ~$90 and the forward PE was ~18.5 and the forward adjusted PE was ~16.7. HSY’s forward valuation was, in essence, similar to its valuation in FY2009 when The Financial Crisis was happening.
Let’s see how HSY’s valuation currently looks based on recently revised projections.
Based on the October 26, 2018 closing stock price of $102.52 and the most recent projected diluted EPS of $4.90 we get a forward diluted PE of ~20.92. Using the adjusted diluted EPS of $5.38 we get a forward adjusted diluted PE of ~19.06.
HSY is currently not as attractively valued as at the time of my June 6th article. I would wait for HSY’s share price to retrace to ~$95 or lower (similar to what we witnessed from mid-April to late July).
Credit Ratings
Moody’s currently rates HSY’s long-term debt A1 and S&P Global rates it A.
Moody’s rating is the top tier of the upper medium grade category while S&P’s rating is the middle tier of the upper medium grade category.
Both ratings are satisfactory for my purposes.
Historical Performance
The following show how HSY has performed relative to the S&P 500 over different timeframes. As you can see from the 14 year chart, the S&P 500’s return rocketed past that of HSY but within the past 1 -2 years the gap has been narrowing.
Source: Tickertech
Dividend, Dividend Yield, and Dividend Payout Ratio
HSY’s dividend history can be found here.
Its dividend compound annual growth rate over the 2004 – 2018 timeframe is as follows.
HSY’s stock split history can be found here.
The $2.756 dividend (two quarterly dividends of $0.656 and two of $0.722) as reported on HSY’s website provides investors with a yield of ~2.63% based on the current $102.52 stock price. This is just shy of 0.5% lower than when I wrote my June 6, 2018 article.
If you wish to calculate dividend yield on the basis of four quarterly $0.722 dividends (the new $0.722 quarterly dividend took effect with the September 14th dividend payment) then investors now receive a $2.888 annual dividend. Using the current $102.52 stock price we get a dividend yield of ~2.82%.
HSY’s $4.90 mid-point of EPS projections for FY2018 and the $2.756 dividend results in a ~56.25% dividend payout ratio. This is superior to the 96.8%, 62.7%, and 74.9% dividend payout ratios in FY2015 – 2017.
HSY’s $4.90 mid-point of EPS projections for FY2018 and the new $2.888 dividend results in a ~59% dividend payout ratio.
As noted in my previous posts, HSY has two classes of stock outstanding, Common Stock and Class B Stock. Holders of the Common Stock and the Class B Stock generally vote together without regard to class on matters submitted to stockholders, including the election of directors.
Holders of the Common Stock have 1 vote per share. Holders of the Class B Stock have 10 votes per share. Holders of the Common Stock, voting separately as a class, are entitled to elect one-sixth of HSY’s Board of Directors. With respect to dividend rights, holders of the Common Stock are entitled to cash dividends 10% higher than those declared and paid on the Class B Stock.
If you own HSY shares, you most likely own the Common Stock.
In 2008, HSY had a Weighted-Average Shares Outstanding (WASO) of 60,777 million Class B shares. As at the end of FY2017 and end of Q3 2018, WASO unchanged at 60,620 million.
In 2008, HSY had a WASO of 228,697 million Common shares. As at the end of FY2017 and Q3 2018, WASO was reduced to 213,742 million and 210,970 million shares.
Final Thoughts
HSY is not an investment with which you will get rich overnight. It is the type of company that is more suited for investors who:
- seek to avoid significant stock price volatility;
- desire a relatively safe dividend where the pace of growth will likely continue to exceed the rate of inflation.
Furthermore, HSY investors should not hope to generate significant capital gains in the short-term.
Investors should be fully cognizant before initiating a position in HSY that there is virtually no likelihood that HSY would ever split itself nor is it likely that HSY will ever be acquired; Milton Hershey saw to this when he created a dual class share structure in which The Hershey Trust Company holds the lion’s share of the voting rights. Previous attempts to acquire HSY were quickly nixed by The Hershey Trust Company.
Finally, I currently view HSY as being overvalued and recommend investors patiently wait for a more attractive level (ie. $95 or lower as we witnessed mid-April to late July 2018).
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long HSY.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
