Hershey: Navigating Exuberance and Risk in the Stock Price
Here is the video analysis of the Hershey Co, if you prefer reading, scroll below:
Hershey has become one of the most requested stocks for analysis in recent months, especially due to its recent 45% decline. While such a drop certainly commands attention, it’s important to look beyond short-term fluctuations and understand the broader trends shaping the company’s performance. Hershey’s stock is currently above its long-term trend, suggesting that recent exuberance in its valuation may not be sustainable.
Long-Term Trends and Short-Term Challenges
Hershey has performed well over the past decade, delivering consistent 10% growth in earnings and cash flows, expanding its product offerings, and maintaining a 4% annual growth rate in its chocolate segment. The company’s long-term outlook projected net sales and adjusted earnings per share (EPS) to continue growing at 10%. However, this guidance has recently been revised down to 6%, signaling a potential slowdown in the company’s growth trajectory.
For a company like Hershey, even slight downward revisions can have significant impacts on investor expectations. The company had a disappointing quarter where revenues didn’t grow, and its updated guidance forecasted a mid-single-digit decline. This is a stark contrast to the steady growth investors had anticipated, which raises concerns about future performance.
The “Delta of the Delta” Tool: Understanding the Risks
To better explain the risk of growth stocks like Hershey, it’s useful to apply the “Delta of the Delta” tool. This tool highlights the compounding effect of a change in growth expectations. When a company is growing at, say, 11% annually, investors tend to reward it with an expanding P/E ratio, which can drive the stock price up. However, if growth slows, the P/E ratio contracts in response, leading to a sharp decline in stock price, especially if earnings are also impacted.
Hershey’s Q2 results were a perfect example of this phenomenon, with sales dropping 16% and adjusted EPS falling by 36%. These figures were a major shock to investors and resulted in a significant reduction in Hershey’s stock price. The company has since stabilized somewhat, but it’s unclear whether it can return to the robust growth of previous years. If earnings per share remain below expectations, this could put further pressure on the stock price.
The Path Forward: Normalization or Continued Decline?
One possible explanation for Hershey’s struggles is that the company may simply be returning to normalcy after a period of extraordinary growth. The pandemic-driven boom in home purchases and global expansion may have inflated margins temporarily, and now the company may be facing increased competition and a reversion to more typical operating conditions. In this scenario, Hershey’s earnings could continue to decline to around $5 per share, with a potential P/E ratio of 15, putting the stock price around $75—a 50% drop from its current level.
While it’s difficult to predict the exact trajectory, investors need to be aware of these risks. The stock’s current P/E ratio of 22 may be too high, given the revised growth outlook. If Hershey’s earnings continue to decline and its valuation adjusts downward, there could be further downside potential.
Dividend Yield and Risk
Hershey currently offers a dividend yield of 3.6%. However, given the potential risks and challenges outlined above, this yield may not be enough to justify the risk of holding the stock at its current valuation. For investors looking for a margin of safety, a P/E ratio closer to 15 and a dividend yield in the 4-5% range would be more attractive. Check the value investing quadrant for better ideas.
Conclusion
Hershey’s recent struggles reflect broader shifts in growth expectations and market conditions. While the company remains a stable business with strong brand recognition and cash flow generation, the current stock price appears to be inflated relative to its growth prospects. Investors should monitor Hershey closely and consider waiting for a better entry point if the stock price continues to correct. A more attractive valuation—closer to a P/E ratio of 15 and a dividend yield of 4-5%—would present a more compelling opportunity for long-term investors.