Hershey’s Discounted Valuations Offer Tempting Upside Potential And Yields (NYSE:HSY)

We previously covered Hershey Company (NYSE:HSY) in November 2023, discussing its near-term headwinds as the inflation rose with record high cocoa/ sugar spot prices, worsened by the declining sales volumes as more consumers chose private label confectionaries.

However, we maintained our optimism that it remained well poised for growth, especially given the aggressive M&A activities over the past few years, with salty snacks delivering double-digit growth, resulting in our Buy rating then.

In this article, we shall discuss why we are maintaining our Buy rating for the HSY stock, with the management consistently delivering stable bottom lines despite the multiple headwinds, with H2’24/ 2025 likely to bring forth improved numbers.

Combined with the discounted valuations and expanded forward dividend yields, we believe that the stock offers prospective dual pronged returns for investors looking for sweet deals.

HSY’s Discounted Investment Thesis Remains Tempting Here

For now, HSY reported a mixed FQ4’23 earnings call, with net sales of $2.65B (-12.2% QoQ/ +0.2% YoY) and adj EPS of $2.02 (-22.3% QoQ/ inline YoY), with FY2023 numbers of $11.16B (+7.2% YoY) and $9.59 (+12.5% YoY), respectively.

The confectionary company continues to face demand headwinds, as it reports lower North America Confectionery volumes at -5.1% YoY in FQ4’23/ -1.9% YoY in FY2023 and North America Salty Snacks volumes at -26.1% YoY in FQ4’23/ +0.7% YoY in FY2023.

While HSY has attempted to counter the declining volumes with price hikes at +9% YoY for North America Confectionery and +5.4% YoY for North America Salty Snacks in FY2023, it is apparent that there may be more near-term uncertainties.

This is because the region comprises the lion’s share of its top lines at 91.4% (-0.3 points YoY) and bottom lines at 95.6% (-0.8 points YoY), with the elevated inflationary pressures and interest rate environment naturally resulting in the tightened discretionary spending and the confectionary company’s decelerating growth.

At the same time, HSY continues to face rising cocoa and sugar price headwinds over the past few years, with the commodities’ future now priced at $7.32K per tonne (+22.2% MoM/ +181.5% YoY/ +214.1% from 2019 averages of $2.33K) and $0.22 per pound (-8.3% MoM/ inline YoY/ +83.3% from FY2019 levels of $0.12), respectively.

For now, the management has attempted to drive cost efficiencies while maintaining its bottom line performance, with “operating costs as a percentage of sales already at a roughly 15Y low in 2024.”

We are already seeing exemplary results in HSY’s relatively stable gross margins of 44.8% (+1.6 points YoY) and operating margins of 22.7% (+1.1 points YoY) in FY2023, compared to FY2019 levels of 45.4% (-0.6 points YoY) and 21.3% (-0.9 points YoY), respectively.

This feat is impressive indeed, with the management also guiding expanded cost savings and bottom line improvements by H2’24/ 2025, as it vertically integrates the newer salty business acquisitions into the legacy Hershey businesses, further aided by the ERP/ digital transformation over the next few quarters.

For now, HSY’s balance sheet remains well capitalized to weather the near term headwinds, with a relatively stable cash of $401.9M (-14.7% QoQ/ -13.3% YoY/ -18.5% from FY2019 levels of $493.26M) and improving debt-to-EBITDA-ratio of 1.25x in the latest quarter (compared to 1.24x in FQ4’22 and 1.74x in FY2019).

As a result of its relatively healthy balance sheet, we believe that its dividend investment thesis remains safe, with an Interest Coverage Ratio of 15.68x and Dividend Coverage Ratio of 1.87x, compared to the sector median of 6.98x and 2.02x, respectively.

The Seeking Alpha Quant has also awarded the HSY stock with an A grade for Dividend Safety, made further tempting by the 5Y Dividend Growth Rate of +11.16% compared to the sector median of +5.24%.

HSY’s Near-Term Headwinds Are Merely Normalization Effects Of The Hyper-Pandemic

The Consensus Forward Estimates

In addition, the HSY management offered a relatively decent FY2024 guidance, with the net sales growth of +2.5% YoY at the midpoint and flattish adj EPS growth.

The management’s commentary and forward guidance are relatively in line with the consensus forward estimates, with the confectionary company expected to record a top/ bottom line CAGR of +3.4%/ +4.6% through FY2026.

This is compared to the historical growth of +6% and +11.7% between FY2016 and FY2023, significantly aided by the inflation induced price hikes thus far.

If anything, HSY’s forward commentary shares a similar sentiment as that of its confectionary peer, Mondelez International (MDLZ), with the latter also guiding an underwhelming revenue growth of +4% YoY and single digit adj EPS growth in FY2024.

This is compared to MDLZ’s historical growth at a CAGR of +4.8%/ +7.4% between FY2016 and FY2023, with the FY2024 deceleration partly attributed to the rising raw material prices, shifting consumer habits, and continuing inflationary pressures.

The same has also been reported by the king of salty snacks, PepsiCo, Inc. (PEP), with it recording FY2023 revenue growth of +9.5% YoY despite the falling volumes of -2% YoY. This is on top of the decelerating FY2024 revenue guidance at +4% YoY.

As a result, readers need not be concerned about HSY’s temporal headwinds, since it is similarly shared by multiple consumer staple companies in an uncertain macroeconomic environment.

While there may be near-term top/ bottom line deceleration, we believe that the confectionary company remains well positioned to pay out its dividends ahead, as similarly estimated by the consensus above.

For now, investors may want to pay attention to the rising cocoa and sugar spot prices, since they pose risks to HSY’s top/ bottom line performance, with a further price hike likely to trigger intensified volume losses to more affordable private label confections.

At the same time, it is uncertain when these spot prices may normalize, with the stock’s prospects likely to remain discounted in the meantime.

So, Is HSY Stock A Buy, Sell, or Hold?

HSY Valuations

And it is for these reasons that we believe HSY’s discounted valuations are highly attractive here, at FWD P/E of 20.18x and FWD Price/ Cash Flow of 14.48x. This is compared to the 1Y mean of 22.57x/ 18.88x and 3Y pre-pandemic mean of 23.03x/ 17.26x, respectively.

The same discount has been observed in MDLZ at FWD P/E of 20.43x and PEP at 20.19x, compared to their 1Y mean of 21.46x/ 22.80x and 3Y mean of 21.43x/ 22.46x, respectively.

We maintain our belief in the long-term durability of confectionary/ salty snacks demand, further aided by the robust branding of Reese’s/ Hershey chocolates and the management’s diversification efforts through salty snacks.

HSY 5Y Stock Price

Furthermore, HSY appears to be well supported at its current trading range of between $180s and $200s, offering interested investors with the improved margin of safety and expanded forward dividend yield of 2.75%, compared to the 4Y average yield of 1.94% and the sector median of 2.04%.

Based on the FY2023 adj EPS of $9.59 and the discounted FWD P/E of 20.18x, the stock appears to be trading near our estimated fair value of $193.50.

Assuming an eventual re-rating in its FWD P/E to normalized levels of 23x along with the estimated FY2026 adj EPS of $10.98, we may see the stock offer an expanded upside potential of +26.8% to our long-term price target of $252.50 as well.

As a result of its (prospective) dual pronged returns through capital appreciation and dividend payouts, we are maintaining our Buy rating for the HSY stock.