Is Hershey Stock a Buy or Sell?

Chocolate giant Hershey (NYSE:HSY) released its full-year 2023 earnings report earlier this month. Despite negative forward guidance, shares rose in the report’s aftermath as management announced a fresh increase of the company’s dividend.

The dynamics surrounding Hershey stock have seen significant changes as a result, forcing investors to reevaluate the company in light of both its lower forward performance projections and its higher annual distribution.

Higher Input Costs To Hurt Short-term Earnings

Cocoa prices are currently rising at a rapid rate, creating difficult operating conditions for Hershey and other candy companies.

Cocoa trades for about $4.64 per kilogram, more than doubling over the last 12 months. This sudden price surge has been attributed to weather conditions in West Africa, where well over half of the world’s cocoa crop is grown. Given how essential this raw material is for Hershey, the rising prices are very likely to squeeze earnings going forward.

This price increase didn’t stop the company from achieving relatively good growth in 2023. Per the recent full-year report, net sales increased by 7.2%. Net income per diluted share also rose at an impressive 13.8%.

Management’s 2024 outlook, however, suggests that the company could be in for a difficult period ahead. Revenue is expected to rise at an anemic rate of 2-3% this year, and earnings will likely be more or less flat as Hershey continues to spend more on its essential inputs.

Here, it’s important to note the highly cyclical nature of cocoa prices. In 2010, for example, prices set records before falling back the following year. Another spike occurred in 2014-2015, but by 2017 prices had retreated to multiyear lows. While cocoa is currently at record highs, history suggests that such peaks are typically followed by valleys once supply-side pressures have been alleviated.

Another minor component of Hershey’s troubles is the mounting effect of protracted inflation. With its input costs rising, the company may have to turn to price increases to maintain its margins. Consumers already hit hard by inflation may reduce spending on chocolates in response, further exacerbating the company’s difficulties.

Hershey is also responding to the current conditions by attempting to increase its operational efficiency. The company plans to cut about 5% of its total workforce, thus reducing its labor overhead as revenues plateau.

Hershey’s Moat Is Still Intact

Despite its short-term troubles, Hershey maintains a strong competitive advantage among chocolate and candy makers.

A study of data from the US chocolate market in 2021 (published in 2023) found that Hershey boasted a 33.5% market share.

Only Mars, with 26.1% of the US market, came anywhere close to challenging the company for overall market dominance.

This competitive moat will likely help Hershey relative to other manufacturers in managing its price increases, as consumers will be more apt to continue buying the company’s branded products even if they have to spend a bit more for them.

Hershey’s Dividend Is Still Attractive

While lower earnings may be a component of Hershey’s outlook in the near future, the company’s dividend is still an attractive feature for income investors.

Management recently raised the quarterly payout from $1.19 to $1.37, an increase of 15%. On an annualized basis, this brings the stock’s yield to 2.85%.

Even better for dividend investors is the fact that Hershey’s dividend payout ratio is still only slightly over 50%. Even with lower earnings expected in the coming year, this fact will likely leave management enough room for future dividend increases.

Management has been prioritizing dividends for several years, and the compounded 10-year growth rate for HSY’s payout is 9.4%. As such, the stock has historically been a solid choice for dividend growth investors.

Is HSY Undervalued or Overvalued?

Hershey currently appears to be trading at a relatively fair price considering its long-term prospects and status as a mature company. Shares are currently priced at about 20.1x forward earnings and 18.7x cash flow, both of which are very reasonable multiples for a company with Hershey’s market dominance.

While some investors may balk at the price-to-earnings-growth ratio of 2.6 and price-to-sales ratio of 3.6, there is little reason to believe Hershey is currently overvalued. This is especially true in the long run, as the effect of high cocoa prices is unlikely to be a permanent drag on earnings.

Wall Street also appears to believe that Hershey is more or less fairly valued. The average analyst forecast for the stock is $207.63. This would give HSY a modest upside of around 6.8% over the coming 12 months.

Hershey’s Potential Risks

It’s worth acknowledging that temporary high input costs aren’t the only potential risk facing Hershey. The company’s debt-to-equity ratio of 0.9 is quite high, potentially raising red flags for the company’s balance sheet.

It is worth noting, though, that dominant, mature consumer companies can often manage fairly high debt loads without difficulty. Coca-Cola, for example, has a debt-to-equity ratio of 1.2x and carries it quite safely.

Concerns over cocoa prices returning to more normal levels cannot be overstated. Cocoa is very sensitive to rainfall and temperature variables, making it particularly susceptible to weather fluctuations.

While studies have found that certain strains of the plant are more resistant to a changing climate, it could take time for growers to adapt to shifting conditions.

In the meantime, cocoa crops could become more uncertain and prices more volatile, potentially creating snags for companies like Hershey that are significantly tied to the commodity’s price.

Is Hershey Stock a Buy or a Sell?

According to 25 analysts, Hershey stock is a buy with 7.5% upside to fair value of $212.50 per share.

Even with minor financial risks and lower earnings likely over the coming year, Hershey still appears to be a moderate buy for conservative investors.

While shareholders probably won’t see particularly large gains from HSY, the generally cyclical nature of the company’s difficulties makes it likely that earnings growth will resume in the future.

If management can tighten the belt this year and hold earnings more or less flat, future years with better cocoa crops and lower inflation could create the conditions for higher net incomes.

For income investors, there could be an even more optimistic view of Hershey. The company’s dividend and prioritization of returning cash to shareholders make it a fairly good fit for those seeking stable income from their portfolios. The stock also has decent dividend growth potential, especially if earnings growth resumes fairly soon.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.