A famous chocolate maker that offers a solid dividend yield and the potential for steady long-term growth is The Hershey Company (HSY, Financial), which traces its roots back to a business founded by Milton Hershey in 1894. According to its 10-K for 2022, it now markets, sells and distributes its products under more than 100 brand names in over 80 countries around the world.
The company describes itself as follows in its 10-K: “ Hershey is a global confectionery leader known for making more moments of goodness through chocolate, sweets, mints and other great tasting snacks. We are the largest producer of quality chocolate in North America, a leading snack maker in the United States and a global leader in chocolate and non-chocolate confectionery.”
Let's take a look at why I view Hershey as a dividend play despite the not-so-high (but still solid) yield of 1.54%. Hint: It has to do with the company's solid long-term growth outlook and cash flow that is supportive for future dividend hikes.
Dividends
In addition to its solid dividend yield, Hershey has a five-year-yield-on-cost of 2.29%. Its dividend payout ratio is 49%, which means the company should have plenty of room for dividend growth as long as it maintains solid and growing free cash flow.
Fundamentals
A company’s ability to pay its dividends depends on its free cash flow and, in turn, on its ability to generate revenue and earnings. In the past, revenue has grown at a reasonable rate, averaging 10.00% per year over the past five years. However, there is significant variation in those rates over different periods.
Over the past 12 months, revenue has gone up 16.80%, while it rose 6.80% over five years and only 4.50% per year over 10 years. These data points suggest that the company has begun growing its revenue more quickly in recent years. That was certainly the case in 2022. According to its fourth-quarter and full-year 2022 earnings release, consolidated sales increased 14.00% and acquisitions added another 3.60%.
Hershey also has a solid earnings history, growing earnings per share by 12.00% over the past 12 months, 13.40% per year over the past three years, 14.50% per year over the past five years and 11.00% per year over the past 10 years.
It’s much the same story for free cash flow, which has risen from $817 million in 2012 to $1.80 billion in 2022. That works out to an 11.70% average growth rate per year. Over the past 12 months, the growth in free cash flow was 14.60%.
While the growth rate has shown variation over the past decade, it’s clear Hershey should be able to generate enough free cash flow to take care of more dividend increases in the coming years.
The company does have a considerable debt load, but nothing too serious. The interest coverage ratio is 16.15, which is satisfactory. Interest payments should not crowd out future dividend increases.
Profitability
The company's gross, operating and net margins are all industry-leading. Return on equity clocks in at a whopping 55.02%, return on assets is 15.39% and return on invested capital (ROIC) is 20.13%.
The ROIC is also consistently higher than the weighted average cost of capital (WACC), showing the company is creating value for shareholders.
For 2022, its WACC was 6.21%, while its ROIC was 19.87%. That’s a positive and another indicator that the dividends should be able to keep growing.
Valuation
With so many positives going for Hershey even beyond its strong brand value, it's no wonder investors have kept bidding up the share price. The GF Value chart considers the stock to be modestly overvalued.
Hershey’s price-earnings ratio is nearly twice the industry median at 32.67. While it also has a reasonable Ebitda growth rate of 10.80% over the past five years, it’s not enough to get the PEG ratio down into the fair valuation range. At a PEG ratio of 3.23, the stock is in overvalued territory. However, I believe the stock deserves a premium valuation due to the reliable dividend and growth outlook.
Gurus
Eight of the gurus followed by GuruFocus had stakes in Hershey at the end of December 2022, according to their 13F filings. The three biggest holdings were those of Jim Simons (Trades, Portfolio) of Renaissance Technologies (2,665,167 shares), Ray Dalio (Trades, Portfolio) of Bridgewater Associates (359,899 shares) and Baillie Gifford (Trades, Portfolio) with 88,918 shares.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Institutional investors and insiders have relatively small ownership stakes in Hershey. The former owned 38.28% of shares outstanding, and insiders held 0.87%. Chairman, President and CEO Michele Buck owned the most shares,151,751 as of March 23, 2023.
Conclusion
For income investors who want a stock with decent growth prospects, I believe Hershey is worth a look. It offers a reasonable yield at low risk, but don’t be surprised if the yield takes several years of growth before it can provide decent income.
