Babylon Capital® Quality & Valuation Analysis On Hershey | Savor The Dividends & Indulge In Value

Following a peak valuation at 28x Earnings, The Hershey Company's HSY stock has declined 31% over the past six months. I believe that HSY is currently undervalued, potentially offering investors appealing risk-adjusted returns and consistent annual dividend growth.

• NTM Price to Earnings Ratio: 18.89x
• 10-Year Mean: 22.87x
• NTM Free Cash Flow Yield: 4.84%
• 10-Year Mean: 4.08%
• NTM Dividend Yield: 2.54%
• 10-Year Mean: 2.38%

Looking ahead, investors can expect to receive 21% more in earnings per share, 18% more in free cash flow per share, and an above-average dividend yield. Considering its strong fundamentals and sector performance, HSY seems to be an undervalued stock that can contribute stability and consistency to a portfolio.

Before analyzing HSY’s valuation, let’s explore why HSY is a high-quality business.

Balance Sheet

• Cash & Short-Term Investments: $471.25M
• Long-Term Debt: $4.01B

HSY maintains a strong balance sheet, highlighted by its "A" S&P Credit Rating and 14.75x FFO Interest Coverage Ratio.

Return On Capital

• 2017: 39.8%
• 2018: 28.6 %
• 2019: 26.4%
• 2020: 24.8%
• 2021: 24.4%
• 2022: 25.7%
• LTM: 27.3%

Return On Equity

• 2017: 86.0%
• 2018: 101.1%
• 2019: 72.8%
• 2020: 64.0%
• 2021: 59.4%
• 2022: 54.3%
• LTM: 54.2%

HSY has strong return metrics.

Revenues

• 2018: $7.79B
• 2019: $7.99B
• 2020: $8.15B
• 2021: $8.97B
• 2022: $10.42B
• 2023: $11.24B * (Full-Year Estimate, Fiscal Year December)
• CAGR: 7.60%*

Free Cash Flow

• 2018: $1.27B
• 2019: $1.45B
• 2020: $1.26B
• 2021: $1.59B
• 2022: $1.81B
• 2023: $1.60B* (Full-Year Estimate, Fiscal Year December)
• CAGR: 4.72%*

Normalized Earnings Per Share

• 2018: $5.36
• 2019: $5.78
• 2020: $6.29
• 2021: $7.19
• 2022: $8.52
• 2023: $9.53* (Full-Year Estimate, Fiscal Year December)
• CAGR: 12.19 %*

Including Full-Year 2023 estimates, HSY has exhibited consistent growth in its revenues, FCF, and normalized EPS over the past five years.

Share Buybacks

• 2013 Shares Outstanding: 227.20M
• LTM Shares Outstanding: 205.78M

By decreasing the number of its shares by 9.4% since 2013, HSY increased its earnings per share by 10.3% (assuming no growth).

As you can see, HSY is a reputable business characterized by steady, albeit moderate, growth.

Now let’s shift our focus to its valuation.

As stated above, investors considering HSY can expect to receive 21% more in EPS and 18% more in FCF per share. Moreover, investors will also receive a healthy 2.51% dividend yield that has been maintained or increased annually for more than 30 years.

It's noteworthy that HSY has achieved an annual increase in EPS since 2008, with an impressive 11.42% compound annual growth rate (CAGR), underscoring its remarkable consistency.

Today, analysts anticipate 2024 – 2025 EPS to grow at modest rates:

2024E: $10.13 (6.3% YoY)

2025E: $10.78 (6.4% YoY)

HSY has a strong history of meeting analyst estimates, even two years in advance. To illustrate its potential, let's consider a scenario where HSY achieves $10.78 in EPS by the end of 2025, factoring in various multiples and starting from a starting price of $189.55 (dividends included).

23x P/E: $247.94 (~15.8% CAGR)

22x P/E: $237.16 (~13.5% CAGR)

21x P/E: $226.38 (~11.1% CAGR)

20x P/E: $215.60 (~8.6% CAGR)

Even though a multiple of 22x or 21x might seem relatively high, it's important to consider that HSY's 20-year average P/E ratio stands at 22.78x. During the most challenging periods of the Great Recession, it was valued as low as 16.25x earnings.

Given HSY's competitive advantages, consistent performance, and safety, it is likely to maintain its premium valuation over the long-term.

Sure, HSY may not achieve a mid to high-teens CAGR. However, for risk-conscious investors and those seeking diversification in consumer staples, the potential for double-digit CAGR on a boring and consistent investment is quite a treat.

*The valuation data utilized in this article is subject to potential changes and may not reflect current market conditions or future developments beyond the time of submission for publication.

Disclosure: I, Dimitry Nakhla, am long HSY. Babylon Capital® and / or its client(s) have positions in the securities discussed in this article. The information contained in this article is intended for informational purposes only and should not be construed as investment advice to meet the specific needs of any individual or situation. Past performance is no guarantee of future results. Information contained in this article has been obtained from sources believed to be reliable but is not guaranteed as to completeness or accuracy.