Hershey: Strong Consumer Spending Will Benefit Stock In 2024 (NYSE:HSY)

Thesis Summary

Today’s research article covers The Hershey Company (NYSE:HSY), in the consumer staples / packaged foods sector, which I gave a hold rating to. My portfolio strategy with this stock is stable dividend income generation and growth, as well as capital appreciation and future capital gains.

A few points supporting my hold rating include revenue, earnings, and dividend growth as well as expected continuing earnings growth, fueled by a strong American consumer and spending. Some offsetting factors include slight overvaluation on price-to-earnings and price-to-book value, which I will go into further.

A key downside risk for a debt-heavy company like this would be a longer period of high interest rates, making debt more costly. A potential upside risk that readers should be aware of would be continued American consumer strength fueling more spending on food products, thereby fueling revenue growth for Hershey’s and attracting more opportunistic investors seeing value in the consumer staples sector.

The current consensus on Seeking Alpha seems bullish from SA analysts, and more cautious/neutral from Wall Street and the SA quant system, so I am taking the side of the cautious ones this time.

Stock & Industry Snapshot

Some quick facts about this stock, from its SA profile, are that it was founded in 1894, has headquarters in Hershey Pennsylvania, trades on the NYSE, and is the parent company behind longstanding brands in the supermarket aisle such as Hershey’s and Reese’s chocolate, Bubble Yum gum, Almond Joy, and others.

Any financial data in this article refers to this company’s income statement, balance sheet, dividend and valuation data, as well as its most recent earnings results. My forward-looking outlook will relate to its next earnings date which is expected in a few weeks on Feb. 8th, as well as longer-term business sustainability.

I would describe this type of business model as a very capital-intensive one as it requires a significant supply-chain / logistics operation worldwide, manufacturing and storage facilities, not to mention extensive quality control as it is a food product. On the other end, supermarkets and drugstores need customers buying enough volume of the product to get it off the shelves so new product can get stocked, as it has a specific shelf life.

In much younger days, one of my seasonal jobs was helping unload the truck at the local CVS drugstore (CVS) and I will never forget the basement storeroom full of boxes of cereal and Hershey’s products, waiting to be stocked. To push product out the door, we often would have weekly sales, and this was when most people still clipped paper coupons. I learned quickly that chocolate bars spending many months in storage are losing money.

That brings me to the sector itself, consumer staples, which according to market data has not performed as well as some other sectors lately:

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Revenue YoY Growth

The most recent YoY revenue growth figures show an 11.4% YoY revenue growth.

As for top-line performance drivers, here is what Q3 commentary had to say about the North America confectionery division:

Gains were driven by sales growth and gross margin expansion, which more than offset higher brand and capability investments.

The Salty Snacks division also saw significant growth:

Hershey’s North America Salty Snacks segment net sales were $345.2 million in the third quarter of 2023, an increase of 25.5% versus the same period last year driven by volume and price realization. Volume increased 22.2%.

As for full-year guidance, the company had a positive sentiment. Here is what the CEO said in her Q3 comments:

We remain on track to deliver our full-year sales and earnings commitments after delivering strong third-quarter seasonal sell-in and successfully implementing our new Salty Snacks ERP system in October.

My outlook for this company is bullish when it comes to revenue, based on double-digit YoY growth in Q3 as well as positive full-year guidance. In fact, Q3 was the best quarter for both revenue and gross profit of the last 8 quarters.

Further, a Jan. 17th article in CNN highlighted the strength of the US consumer, which I think may help Hershey’s as well as it sells consumer food products:

Americans spent at a faster clip in December, closing out a year of surprising economic resilience largely driven by the US consumer.

December’s strong retail-sales figures suggest that American shoppers could continue to fuel the US economy in 2024.

Earnings YoY Growth

When it comes to bottom-line earnings, the company saw a nearly +30% YoY growth.

This is despite both interest expenses and total operating expenses ticking upward on a YoY basis.

On a longer-term trend, all of the last 5 quarters have seen a higher net income that in July 2022.

One key driver to mention that has affected capital spending has been the company building a new ERP (enterprise resource planning system), which is used in processes like supply-chain and others.

Here is what those numbers looked like, according to Q3 results:

Capital expenditures of approximately $800MM to $850MM, driven by core confection capacity expansion and continued investments in digital infrastructure including the build and upgrade of a new ERP system across the enterprise.

My outlook on earnings is a bullish one, not just because of the double-digit percentage YoY earnings growth in the midst of rising expenses, but also due to the previously mentioned positive outlook on revenue and consumer spending, which should help net income also. In addition, the ERP system upgrades are a one-time cost.

Dividends 10 Year Growth

As a dividend-income investor, I am building a portfolio around dividend income primarily so when it comes to Hershey’s what I am looking for is proven dividend growth over a decade.

We know the annual dividend went from $2.04 in 2014 to $4.46 in 2023, a nearly +119% growth in 10 years.

If I consider that fact, along with a modest 2.50% dividend yield and a history of steady quarterly payouts, it adds tailwind to the bullish thesis.

As for future outlook on dividend hikes, I think they would be sustainable not just because of continued profitability growth but also continued positive cash flow this company has achieved, making it more likely (though not guaranteed) that the board will continue to want to return profits back to shareholders in 2024.

Valuation: Price to Book Value (P/B Ratio)

As we go into the next topic which is valuation, let’s take a look at the most recent chart for this stock, tracking the share price vs the 200-day SMA:

The chart shows us the share price of $190.46 has dropped around 14% below its 200-day moving average.

Valuation data also shows us that the forward price-to-book value (P/B ratio) is at 9.53. while its sector average is only 2.74. So why the huge multiple on Hershey stock?

We can see from the balance sheet that equity grew in Q3 to $3.96B vs $3.08B in Oct 2022, a 28% YoY growth. So, we have a case of bearish share price along with double-digit percentage growth on equity.

After some digging, I am of the opinion that this company’s equity is low in relation to some peers, yet has a share price of near $200. Consider, for example, its peer in the consumer staples category, Mondelez Intl (MDLZ). Mondelez is trading for under $73 yet has equity of $28.5B along with YoY equity growth. It also has a better P/B valuation, at just 3.53x forward book value.

While I consider Hershey’s P/B ratio overvalued, looking ahead what could help is if they can pay down some of their +$4B in long-term debt, to give equity a boost.

Valuation: Price to Earnings (P/E Ratio)

As for the forward P/E ratio, we know it is at 20.64, while the sector average is slightly lower at 19.22.

As for the drivers of this elevated valuation of nearly 21x earnings, let’s break it down: we know the share price is double-digit percentages below its moving average while the earnings have grown by double-digit percentages YoY.

This time Hershey’s and Mondelez are similar when it comes to valuation, both hovering around 21x forward earnings.

Within the consumer staples segment is also General Mills (GIS), who is trading around $63 yet has achieved $595MM in earnings, likely why its P/E valuation is just 14.59. Compare that to Hershey’s that is trading at $190 but only achieved $518MM in earnings.

So, the evidence shows Hershey’s is overvalued slightly in the case of forward P/E ratio, and for the share price it is trading at it ought to keep growing those earnings much higher.

Key Risks

In determining a key risk for Hershey’s, I thought about what would be a downside risk for a major consumer staples company like this one going into 2024, but also a potential upside risk, seeing as I gave it a neutral rating.

Because it is a consumer “staple”, or essentials company and not consumer discretionary, I think in the event of a potential recession in 2024 it would be a lesser risk for supermarket food products than for dining out at restaurants.

The downside I see is for interest rates to stay higher for longer, which could add to the interest expenses of a company like this with already $4B in debt, and a capital-intensive business that depends on debt financing to an extent. That will impact the income statement with higher interest costs.

CME FedWatch, a rate tracking site, already is predicting a 56% chance rates stay the same even after the Fed’s March meeting, however the good news is that there is also a 50% probability of rate cuts after the July meeting.

As for an upside risk, ironically I think it is also tied in some way to the Fed. If the Fed keeps rates higher, it will be because the economy is too hot and they want to cool it down, by making borrowing more expensive. However, a hot economy, plus the consumer spending I mentioned earlier, is likely a tailwind for consumer products companies like Hershey. Growing consumer confidence in 2024, if it continues, may mean the hypothetical customer buys a few extra chocolate bars on the next shopping trip, and it will reflect in upcoming earnings results.