John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Buying a good company when it's experiencing a temporary setback can be a profitable investing strategy.
With that in mind – and with Halloween only two days away – let's take another look at Hershey Co.
When I wrote about the chocolate and candy maker a year ago , I highlighted its growing earnings and dividends but warned that, given its rich valuation, "the stock could turn into a gooey mess in a hurry" if its earnings disappointed.
Sure enough, that's precisely what happened. The stock closed Tuesday at $95.53 (U.S.) on the New York Stock Exchange, down 11.6 per cent from its record high of $108.07 reached in February. During the summer, it fell as low as $88.15.
It's important to realize that nothing has fundamentally changed in Hershey's long-term outlook. The company has been facing volatile commodity costs and tough competition, but these are nothing new for a firm that has been serving up sweet treats since 1894. Despite such challenges, the future still looks bright for North America's largest chocolate maker.
Here are five reasons Hershey may be worth a look for dividend investors. Remember to do your own due diligence before investing in any security. Also bear in mind that Hershey reports third-quarter earnings on Wednesday, and the stock could react if results are better or worse than expected.
Delicious dividends
With the exception of a short hiatus during the 2008-09 financial crisis, Hershey has raised its dividend annually (and occasionally more often) for decades. Over the past five years, the dividend has climbed at an annualized rate of 10.8 per cent, with hikes typically announced in July. The yield of 2.2 per cent isn't huge, but given Hershey's growing free cash flow, solid balance sheet (its debt is rated single-A by Standard & Poor's) and conservative payout ratio of 50 per cent of earnings, the dividend will almost certainly continue to rise at a healthy pace.
Growing sales and earnings
For the five years through 2013, Hershey's sales grew at an annualized rate of 6.8 per cent and adjusted earnings per share climbed at an annualized 14.6 per cent, according to Bloomberg. These are impressive numbers, but Hershey's growth has recently slowed. In July, the company said it expects 2014 sales growth to be at the low end of its long-term range of 5 to 7 per cent. Citing higher commodity costs, particularly for dairy, it also warned that adjusted earnings per share growth for 2014 will be at the low end of its target of 9 to 11 per cent.
The silver lining? Hershey also announced price increases averaging 8 per cent across most of its products, a move that will help to offset higher costs for raw materials, packaging, transportation and utilities. The company said the price hike will not have a material effect on 2014 results but "the majority of the financial benefit from this pricing action will impact earnings in 2015."
Strong brand portfolio
One reason Hershey can raise prices is that it owns or licenses many of the world's top candy brands, including Hershey's, Reese's, Twizzlers, Jolly Rancher, Almond Joy and others. Candy and chocolate are inexpensive indulgences for consumers, who will pay up for their sugar fix even if prices rise slightly.
What's more, Hershey has a track record of successful product innovation that squeezes more revenue from existing brands. For example, in addition to Hershey's chocolate bars, there are now Hershey's ice cream toppings, bottled milkshakes, sugar-free products, baking ingredients and – introduced earlier this year – a line of Hershey's spreads to take on Nutella.
Other avenues for growth
According to Edward Jones analyst Jack Russo, the premium chocolate category is both faster-growing and more profitable than traditional mass chocolate. "We believe this represents an attractive growth opportunity for Hershey, particularly in the dark chocolate segment, where the company currently holds a leading 47-per-cent market share," Mr. Russo said in a recent note.
Hershey also has opportunities to expand globally. Late in 2013, it bought an 80-per-cent stake in Shanghai Golden Monkey Food, a Chinese company whose chocolate and snack sales have been growing at double-digit rates. Mr. Russo said Hershey is probably looking for other acquisitions to bolster its presence in foreign markets and "appears to be building some cash on the balance sheet for perhaps just this purpose."
The stock is fairly valued
Hershey trades at about 21 times estimated 2015 earnings, which is similar to its five-year average price-to-earnings multiple. The stock is by no means cheap, but companies with strong brands and steadily growing sales and earnings usually command a premium. Short-term stock moves are impossible to predict, but long-term investors can look forward to growing dividends and the strong possibility of share price gains.
John Heinzl