HSY - Hershey: Too Sweet For Me

2023-07-17 12:23:46 ET

Summary

• The Hershey Company has been unleashed over the last couple of years.
• Savvy dealmaking and better operational performance has lifted its performance and Hershey shares.
• Hershey's current valuation factors in a lot of good news, certainly in this interest rate environment, making me cautious here.

All the way back to 2018, I wondered if cheese puffs would go well together with chocolate after The Hershey Company ( HSY ) acquired Pirate Brands from B&G Foods ( BGS ) . This deal left me wondering about Hershey's better-for-you dealmaking strategy, as a prevailing premium valuation with flattish growth did not look too compelling in my book.

I have been surprised by a strong operational performance ever since, and in response to that a strong share price performance as well, although that this same performance has raised the bar a lot here.

A Recap

Pressured by activist investors, Hershey resorted to M&A efforts in 2017 and thereafter to create some growth, which included the purchase of better-for-you brand Amplify in 2017, and a $420 million deal for Pirate brands a year later.

The deal would add some incremental revenues and profits to a business which generated $7.51 billion in sales in 2017, with mid-single digit revenue growth seen in 2018, and earnings seen at around $5 per share, with adjusted earnings per share seen a bit higher, but GAAP earnings seen a bit lower than that number.

Pro forma net debt would jump to $4.5 billion and with EBITDA seen at nearly $1.8 billion, leverage ratios of 2.6 times were quite reasonable. Amidst this background, shares traded around 20 times earnings (a bit higher based on GAAP earnings, and a bit lower based on adjusted earnings) with shares trading just above the $100 mark at the time. Calling the valuation full, I was happy to consider if shares would fall to the $90 mark, as shares have never seen those levels again.

Doing Very Well

Since 2018, the company has seen rather spectacular results given that this is a consumer staple business, with shares having risen nearly 150. Shares of Hershey are now trading at $239 per share, after hitting a high of $277 in recent months.

Fast forwarding nearly five years in time, we have seen Hershey grow sales from $7.5 billion in 2017 to $10.4 billion in 2022, as results last year rose by $1.5 billion aided by inflationary pressures and dealmaking, notably a $1.6 billion deal to acquire Pretzels. Pre-tax profits of $2.26 billion worked down to solid margins being equal to 21.7% of sales, actually down a point on the year before.

Amidst lower tax rates and a small reduction in the share count, the company grew diluted earnings from $7.11 per share to $7.96 per share. Adjusted for among others derivative losses, earnings advanced to $8.52 per share as the advancement of Hershey have been driven largely by organic strength. Net debt came in at $4.3 billion, actually down from 2018 and with EBITDA having improved to more than $2.6 billion, leverage ratios have fallen a full turn to 1.6 times.

The underlying momentum has been solid as a 16% increase in 2022 sales came to fruition with all components of sales growth contributing. Pricing was the biggest contributor to growth at around 8%, with both acquisitions and volume/mix each adding about 4% to reported sales growth. The company furthermore outlined a decent outlook for 2023 which called for sales to grow by 7% at the midpoint of the guidance, with adjusted earnings per share set to grow by 10%, making a near $9.50 per share number in sight.

With shares having risen to $239, it is clear that the multiple has risen to about 25 times earnings. This in a higher interest rate environment, as investors recognize the real underlying strength and not just the result of acquisitions, as well as organic growth and better execution as well, with leverage having come down quite a bit.

With the impact of a stronger dollar in 2022 subsiding, Hershey posted a 12% increase in first quarter sales to $2.99 billion as operating profits rose from $721 million to $800 million. Amidst continued share buybacks, diluted earnings per share of $2.85 were reported, some twenty-eight cents higher than the year before.

Of the near $3 billion quarterly revenue base, Hershey is still reliant on its near $2.5 billion North American confectionary business, although that the $270 million North American salty snacks business and $265 million international business showed the strongest growth. Net debt has fallen further to $4.2 billion, reducing leverage as the company upped the full year guidance. Both the midpoint of the sales guidance and the earnings per share guidance were hiked by a percent, now seen up 8% and 11%, respectively.

It should be noted that cash flow conversion was not as strong as the reported earnings, with capital spending seen at $800-$900 million, more than twice the annualized $400 million depreciation and amortization charges. This created a more than $2 per share headwind as a result of net capital investments.

A Final Take

The reality is that Hershey is a true dividend aristocrat, having paid out more than 370 consecutive dividends in a row after the company was founded in the late 19th century. While a current 1.7% dividend yield is not necessarily very high given the prevailing level of interest rates and versus its peers, it has tripled over the past decade, as its dividend growth is strong.

With some key brands like Hershey's, Reese's, and Kisses being strong and having global recognition, to various degrees, Hershey is very strong and positioned to outperform. That said, the valuations are quite high at current levels, albeit perhaps justified by some operating momentum in recent years, with sharer now down 25% from the highs seen earlier this year.

There are some headwinds as well, as sugar prices are spiking as a result of global droughts, and perhaps more overtime once governments start to more effectively tax sugar, the same way they have down with tobacco, among others.

Amidst all this, I am mindful of The Hershey Company's strong track record, but the high current valuation as well. I am considering to initiate on dips towards the $200 mark, but this is still a long way from current levels, of course.

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