Don't Bet Against Warren Buffett: Here's Why Hershey Will Bounce Back
Popular candy and chocolate maker The Hershey Company (HSY) - Get Report is a household name across the world, with products sold in the U.S. and 80 countries.
Hershey seems like a solid buy. With strong brand recognition, robust cash flows, and consistent dividends, it ticks all the boxes in Berkshire Hathaway owner Warren Buffett's checklist of ideal investment characteristics. The stock, however, is hovering at a 52-week low, largely driven by weakening demand.
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So does Hershey, then, really make the cut? Should you follow Buffett's lead on this stock or give it a pass? Let's take a look.
The Importance of the Economic Moat
Buffett is a long-term player and affixes immense importance to a term coined by him: economic moat. It reflects his motto for looking at companies with strong competitive advantages that help them sustain good cash flows over a long period of time.
Hershey boasts a portfolio of famous brands, such as Reese's, Kit Kat, and Jolly Ranchers and leads the candy market with a share of 31.2%. This is likely to grow by 2.7% over 2015-to-2019. While players such as NestleSA and Mondelez International Inc are close on its heels, Hershey still scores high on recognition and preference in a growing market.
The Healthy Dividend Quotient
Dividends are another favorite metric of Buffett's and Hershey scores well here, too. The company offers a yield of 2.8% and has consistently increased dividends over the past 35 years (except during the Great Recession when it kept dividends unchanged).
Hershey has been able to achieve this feat by maintaining robust cash flows to fund operations and payback investors -- achieving positive cash flows since 2000 and sustaining them through the 2008 financial meltdown.
The Shadow of the 52-Week Low
For the third quarter of 2015, Hershey recorded $154.8 million in profits, down from the $223.7 million in the same period a year ago -- but a complete U-turn from the $100 million loss in the second quarter. While it beat analysts' estimates of $1.13 adjusted earnings-per-share to come in at $1.17, it narrowly missed estimates of $1.98 billion in revenues to stand at $1.96 billion.
For five quarters, Hershey's has lowered its sales forecasts. Less frequent supermarket visits leading to lower impulse buying, competition from healthier items like granola bars, and weakness in high potential markets like China have all added downside pressures on the demand for Hershey's products.
This trend is clearly reflected in its stock price, which has steadily fallen (over 19% from the start of this year to $85 today).
What Hershey Can Really Deliver
Despite its weak third-quarter numbers, Hershey kept something in store for its shareholders -- $124 million by way of dividends and $230 million in share buybacks in the quarter.
Customers also seem to have absorbed the 8% increase in the company's product prices, a move that helped boost revenues by 1.5% year-over-year in the third quarter.
Looking for organic and sustainable growth, the company is investing in innovation, e-commerce-related activities, and cost saving initiatives. It is also actively targeting high-potential overseas markets such as China, India, and Mexico. While China and Mexico featured in the top 10 markets for retail confectionery sales last year, India is expected to touch $2.2 billion in 2018.
While Hershey's valuation of 19.13-times forward price-to-earnings (P/E) is a bargain compared to Mondelez's 21.60, what really stands out for Hershey's is its century old connection with American families and the sustainable long-term growth view of its management.
So, despite its temporary run of bad fortune, Hershey's still has a lot going for it: likely revenue and earnings growth in coming quarters, market expansion strategies, and sustainable high yields. And: It rarely pays to bet again the judgment of Warren Buffett.
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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.