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It's been a miserable year for consumer staples stocks. Just two years ago, food, liquor and tobacco stocks were among the hottest in the market. That's because investors were chasing the safety of dependable brands and relatively high dividends. Hershey Co (NYSE: HSY ) enjoyed a similar fate. Hershey stock rallied to as high as $115 following news of a takeover offer from MondelezInternational (NASDAQ: MDLZ ) in 2016.
That would be as far as HSY stock would run, though. Shares leveled off until late last year. Now, however, Hershey is down more than 20% since the start of the year. That's a large drop for a company of HSY's low-volatility nature. Like other companies in the sector, Hershey is falling largely due to interest rate concerns and the general concerns about the future of branded food products.
Cocoa Cost Problems
More specifically to Hershey, there's another factor at play here - cocoa prices have shot up 50% in just a few months. This gets the short-term trading crowd nervous since it will impact 2018 earnings to some extent.
I went looking in Hershey's filings, and the company mentions raw cocoa as its largest cost, followed by the likes of sugar and milk. But it doesn't disclose precisely how much exposure it has to cocoa prices, or to what extent the company has hedged. We'll see what happens with earnings later this year.
In any case, I don't care much about short-term commodity price swings. Hershey's management has decades of experience dealing with changes in its input costs. Management knows what they are doing, and ultimately, these commodity price spikes rarely last more than a year or two. Commodity markets revert to the mean - generally, quickly.
Speculators dumping a stock because of a transitory earnings hit from commodity prices is one of the most predictable ways to get good entry prices for quality stocks. And, if you're more of a trader, wait until commodity prices spike in the optimal direction for your firm and then sell into the temporarily inflated earnings.
Hershey's Still Sweet
While nervous folks are dumping food stocks indiscriminately, it's setting up a golden opportunity for more patient investors. Hershey is one of the top-tier consumer staple companies out there. That's because it is managed by a foundation that makes management focus on long-term plans. I love companies that are focused on long-term wealth generation for their owners, rather than playing the quarterly earnings game.
On top of that, chocolate is generally more stable than even the broader food category during hard times - the brands are very strong and the price points are low enough to avoid consumers switching to off-label. In the case of Hershey, we're dealing with a company growing earnings at 9% per year over the past five years that is now trading at less than 16 times forward earnings. That'd be pretty respectable for even a normal dividend aristocrat-style growth-and-income stock, but it's especially intriguing for a higher-quality operation like Hershey.
Leading Brand and Business
Hershey and Mars Corporation effectively operate a duopoly in the American confectionery market. Hershey has 31% market share and Mars 30% as of 2017. The next nearest competitor is Mondelez way down at 5% of the market. More specifically, just talking chocolate, Hershey leads Mars 44% to 30% - with no other peer above 10%. This gives Hershey an economically attractive position, since it can maintain healthy prices and high profit margins.
Investors have been left with a bitter taste around Hershey stock in recent years due to some less-than-successful international expansion efforts. However, those missteps shouldn't be blown out of proportion. The company dominates its home market, and management is retooling things overseas.
On top of that, Hershey is looking to branch out. The company recently made a deal for Amplify , a snack foods label focused on less-unhealthy packaged snacking options. Given Hershey's strong fiscal position and dominance of its market, it will have plenty of cash to keep modernizing its business and adapt to changing consumer preferences.
Hershey Stock: What Happens Now
HSY stock made a sharp move downward in February. Since then, shares have continued to melt. They recently broke the $95 level and quickly slumped to the previous support area at the $90 mark. Now at around $90, Hershey's forward price-to-earnings ratio has fallen to less than 16, and the yield is up to 3%. Dating back to the 1980s, the only time Hershey stock has ever yielded more than 3% was (briefly) during the financial crisis.
That attractive starting dividend is combined with an aggressive capital return program for shareholders. As recently as 2006, Hershey stock paid under a buck a share in dividends. It's ramped that up to $2.62 per share today. In fact, Hershey has averaged a 10% annual dividend growth rate over both the past five and ten years. Start at 3% and compound at 10% a year and you've got quite the income investment.
On top of that, Hershey buys back a small, but consistent, amount of stock each year. Over the past six years, it has eliminated almost 10% of the outstanding share count. That adds to earnings and paves the way for continued sizable dividend increases. With the HSY stock price down lately, management is now getting more bang for their buck with 2018's share repurchases and helping to put a floor under the stock.
Admittedly, 2018 is likely going to be a forgettable year for the company, especially given what's happening with chocolate prices. The tax cut will help with earnings, but only to a certain degree.
Regardless, this is a great time for patient investors to take advantage of short-term concerns and stock up on cheap Hershey shares.
At the time of this writing, Ian Bezek owned Hershey stock. You can reach him on Twitter at @irbezek.
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