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Hershey's Dividend Looks Sweet Today

Erin Lash, CFA

Erin Lash: Hershey offers one of the more attractive dividends in the packaged foods space yielding north of 3%, and we think further growth is in the cards. Over the past year, Hershey has reined in its spending in international markets, which we view as prudent given we've long thought Hershey does not maintain a competitive edge relative to rivals that have played in these regions for decades.

Hershey is subsequently funneling that spend to support its leading brand mix in the U.S., where it controls north of 45% of U.S. chocolate. While private label threats are minimal in the confectionary aisle, Hershey is not immune to competitive headwinds from both other branded operators as well as other snacking alternatives. And as such, we view the increased investments behind research and development as well as marketing, which we forecast will average around 8% of sales annually over the next 10 years, as a means by which to support its leading brand portfolio, as well as its relationships with retail partners.

The bulk of these assumptions support our forecast for 3% organic sales growth on average over the next 10 years as well as 200 basis points of operating margin improvement to around 23%. These financial results should enable Hershey to generate outsize cash flows. With our forecast calling for free cash flow as a percent of sales to average in the midteens. While we anticipate that Hershey will continue to pursue select acquisitions similar to it's purchase of Skinny Pop owner Amplified late last year, we surmise that returning excess cash to shareholders will remain a top priority.

In this vein, the Milton-Hershey School Trust controls 80% of the voting rights of Hershey sharers. And as a result, we think the firm's commitment of funding its dividend will persist, given the school is dependent on this income to fund its operations. As a result, we expect that Hershey will continue to allocate 50% of it's earnings toward dividends annually, implying around 7% growth on an annual basis over our explicit forecast. With shares trading at more than a 20% discount to our $116 fair value estimate, we think investors would be wise to indulge in Hershey shares.