Summary
- Having raised its dividend for 11 consecutive years with its recent 4% dividend increase, Hershey is a Dividend Contender.
- While Hershey's operating results weren't overly positive, they weren't overly negative, and the investment thesis remains intact, in my opinion, with strong brands and an investment grade balance sheet.
- Adding to the case for an investment in Hershey is the fact that shares of the company are trading near fair value.
- Between the 2.2% yield, 7-8% annual earnings growth, and 0.1% annual valuation multiple expansion, shares of Hershey are positioned to deliver 9.3-10.3% annual total returns over the next decade.
In a COVID-19 business environment that is fraught with uncertainty, it is especially important to focus on acquiring shares of high-quality dividend paying stocks that are trading at or below fair value.
Within the confines of high-quality dividend stocks, one can look no further than Hershey (HSY), which has been in business since 1894 and has paid uninterrupted dividends for longer than most of us have been alive.
As I will discuss below for the first time since I initiated coverage in Hershey last July, Hershey boasts a well-covered dividend that has the potential to grow in the range of 7-8% annually over the long term, Hershey delivered fair operating results for Q2 of this fiscal year and maintains firmly investment-grade credit ratings from the major ratings agencies, and lastly, shares of Hershey are currently trading near my estimate of fair value.
Hershey's Dividend Remains Safe
Despite the fact that Hershey's yield of 2.21% is well within the S&P 500's current 1.86% yield, I'll always remain an advocate of examining the safety of a stock's underlying dividend.
While it doesn't take too much analysis of Hershey's dividend to know that it is safe, an assessment of Hershey's dividend payout ratios is helpful to gain an understanding of Hershey's flexibility in its payout ratio going forward and whether future dividend growth will be in line with future earnings growth, less than future earnings growth, or greater than future earnings growth.
Hershey generated $2.58 in diluted EPS in H1 2020 (per data sourced from page 2 of Hershey's most recent 10-Q) against $1.546/share in dividends paid during that time, for a diluted EPS payout ratio of 59.9%.
Moving to FCF, Hershey generated $614.047 million in operating cash flow in the first half of 2020 against $185.784 million in dividends paid out, for total FCF of $428.263 million.
Against the $314.279 million in dividends paid out during this time (according to data sourced from page 5 of Hershey's most recent 10-Q), this equates to an FCF payout ratio of 73.4%.
While Hershey's payout ratios are notably higher than they were last year during this time, it's important to take into consideration the disruptive impact of COVID-19 on Hershey's International and Other segment.
Over the long term, I fully anticipate Hershey's dividend growth will at the very least track earnings growth or slightly exceed earnings growth.
Given that Yahoo Finance analysts are forecasting 6.9% annual earnings growth over the next 5 years for Hershey and that I expect Hershey's payout ratios to rapidly return to their previous levels, I believe that Hershey's annual dividend growth will slightly exceed its forecasted annual 6.9% earnings growth and that the stock will manage to grow its dividend by 7.75% annually over the long term.
