This “tease” isn’t from a regular ad, it’s from a “free” article that Porter Stansberry posted earlier this week… but a couple readers asked about it, and I was curious myself, so I jumped in to check out the clues.
Maybe it’s just that this ad hints at a non-sexy and rational-sounding investment at a time when I’m getting a little jittery about the irrational valuations out there, but this language from Porter is why I looked a little further:
“It’s time to revisit – and re-recommend – an ‘old faithful.’
“This stock should be a mainstay in your portfolio. It will provide ballast and stability when the market gets choppy. And given a recent decline in the share price, this stock should do well from here even if a market correction takes longer to show up than we expect.
“Plus, it’s a perfect example of how capital efficiency produces excellent returns over the long run…
“As we wrote when we first recommended this stock, ‘The longer you hold this stock, the more rapidly your wealth will compound, and you’ll never have to sell – ever.'”
So what’s the stock? He says it’s a slow-growth business, which will turn off most investors… and that they pay a dividend, which typically exceeds capital expenditures, and has increased its annual free cash flow per share by 15% since they’ve owned it.
This talk about “capital efficient” businesses is not a new thing, Stansberry has been touting that idea for years now in his free commentaries… and there’s certainly nothing wrong with that, companies that can grow without needing a lot more capital, either because they can self-finance through high margins or because they are “asset light,” are obviously appealing.
Indeed, that’s probably what Warren Buffett would have been looking for 20 or 30 years ago, before his capital base got so big that he started to think of reinvestment potential as being more important than cash returns (his huge pile of cash arguably got him asking, “can I reinvest billions in this to grow the business, and make a reasonable return on that excess capital I have?” instead of “can this business thrive without more capital?”).
And he compares the company to General Electric (GE), which has finally become the poster child for “disastrous capital management” in recent years. He says that both companies had almost identical revenue growth over the past 25 years, roughly 3.4% per year… but that GE saw its free cash flow per share actually decline over that 25-year period (by 16%, in total) while “Company A” saw 3,571% growth in free cash flow per share (15% per year).
His more detailed expounding on that helps us to easily confirm (and, frankly, he’s not trying that hard to keep it a secret) that Porter is again talking up and recommending Hershey (HSY), the candy giant.
He went into his bullish case for Hershey in some detail back in January here, and apparently first recommended the stock at the end of 2007, since which time it has beaten the S&P 500 (roughly 200% vs 130%, including dividends). He even dubbed it a “Magic Stock” a couple years ago.
The biggest news out of Hershey recently has been the acquisition of Amplify at a huge premium, in a deal that closed on January 31. Perhaps that’s part of the reason why HSY stock is right now in what I’m pretty sure is the worst decline it’s ever had since Porter recommended the stock back in 2007, down about 22% from the highs it hit just about a year ago and almost re-tested in December — Amplify is not a massive company, but at over a billion dollars it was a meaningful deal for a $20 billion company like Hershey, and it certainly looked expensive. Perhaps it even looked a little desperate, at a time when Campbell Soup was also paying a premium price to buy a snack company (Snyder’s-Lance) and when packaged foods companies all over are struggling to grow and to understand the new retail environment.
Hershey has been trying to expand beyond the candy aisle for a while, and Amplify is the biggest acquisition they’ve done recently, but the company has really been built on 50+ years of meaningful deals and acquisitions — beginning with the purchase of H.B. Reese (yes, of peanut butter cup fame) in 1963 and including acquisitions over the years of Twizzler, the licenses (from Nestle) for Kit Kat and Rolos and from Cadbury for most Cadbury-branded chocolates in the US (including York, Almond Joy, and others), along with premium brands like Scharffen Berger and Dagoba. That, along with organic product developments over the years (from the Kiss in 1907 to the Reese’s Pieces that blew my mind as an elementary school kid in 1977), has built the portfolio of recognizable brands to what it is now.
Amplify’s big brand is Skinny Pop popcorn, which arguably leads the “ready to eat” popcorn space right now, and they also have what I’d call “emerging” brands in corn chips and potato chips that may or may not really take off, and the deal was talked up as giving Hershey more access to the warehouse shopping market, to give you some idea of how the calculus for food makers has changed. Hershey is looking to build on that snack business and consolidate a few different businesses that they own, apparently, as they move the HQ of their also-recently-acquired Krave jerky business to Austin to collaborate with the Amplify folks.
Porter’s “capital efficiency” thesis for Hershey is summed up pretty well from his (free) January article here:
“Hershey doesn’t have to spend much (hardly anything at all) to maintain its plants and grow. It’s been making the same basic product for more than 100 years – a chocolate bar. There’s no radical R&D required, and no new massive factory build every five years. Thus, as sales expand, more and more of the profits can be distributed to shareholders via dividends and share buybacks. Over time, this advantage compounds and becomes almost unbeatable.”
And really, what Porter’s talking about with that “enduring brand” and “put a smile on your face” commentary is mostly based on what led Milton Hershey to sell his caramel business in 1900 and focus on what is still Hershey’s core business… as he is widely quoted as having told his cousin at the time, “Caramels are only a fad. Chocolate is a permanent thing.”
If you want further reason to have some confidence in the candy aisle, where it has seemingly been a bit tougher for competition and store brands to take much space from the Mars/Hershey/Nestle oligopoly, you need go no further than Warren Buffett, who had a widely-publicized beef with Elon Musk about whether candy brands (like Berkshire’s See’s Candy) with “moats” are valuable… Bloomberg came down on Buffett’s side, incidentally, with this interesting story last month about the enduring brand-driven strength of the candy companies.
So what’s the story now, why is Hershey falling?
Well, it arguably got a bit too expensive in 2017, considering the “slow growth” nature of the enterprise, and has moved up and down over the years as earnings have fluctuated and optimism has waxed and waned — at the peak, the trailing PE ratio was above 40 and the forward PE close to 25. Porter’s answer to “why are we getting this chance to buy” is that “the stock market is concerned about rising costs and shifting consumer behavior,” and his short answer is that “we find both concerns shortsighted.”
Which isn’t a guarantee, of course, people have considered packaged foods in general to be a stronghold against collapse for years, but sometimes big trends do change — even if it seems very likely to me that candy is an enduring “indulgence” that will probably stick around, and that our fondness for known candy brands, and their collective might, will help keep the smaller “disruptors” out of the checkout lane at the supermarket.
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So the price looks a bit more appealing now, with a forward PE of about 16 and a trailing PE of 19 — or, going just by the company’s own forecast given in their latest quarterly press release of $5.33 to $5.43 in adjusted earnings per share, you can think of it as being at 17X 2018 earnings. Analysts are not being aggressive about Hershey at all, they have their forecasts for the year at the bottom of Hershey’s provided range ($5.33), and, in what seems a bit unusual for a large stock that’s active in the bond market (analysts don’t generally like to talk down companies that might bring their bank some business), there are more “underperform” and “sell” recommendations (5) than there are “buy” or “outperform” (4)… a dozen analysts rate it as a hold, though the average price target of $97 does represent a little upside.
And just last week, the stock dropped a bit more as they filed a debt securities shelf offering… though that shouldn’t be any surprise, they have $2.5 billion in debt maturing over the next year and will need to refinance most of it with a new tranche of debt. That should be pretty well taken care of soon, I imagine, since they already raised $1.2 billion last month with some new 3-5 year bond offerings, at low rates… so even though the Amplify deal (which they did with cash) increased their debt, and even though Moody’s reviewed their credit rating after that deal, Hershey bonds are still firmly “investment grade” and they still get to borrow on the cheap (even their ~30 year bonds are trading at an effective yield of only 4%).
So what to do? Hershey is certainly an enduring brand and a powerful company, though it’s also not likely to shoot higher in a hurry anytime soon — partly because I think there’s not much likelihood that the company will be bought out in the continuing merger wave. The notion of a takeover has been effectively dismissed by the Hershey Trust, which has a supermajority controlling vote, several times over the years — Wrigley tried to buy them in 2002 at a fat premium, and Mondelez tried again in 2016… and that Trust has also effectively stopped Hershey from merging with or acquiring other big players in riskier deals, like a talked-about deal with Cadbury back in 2010 (Cadbury is now owned by Mondelez).
So that history of a “big deal talk” every couple years might lead you to expect that it will come around again, and it certainly could, but my guess that since almost every big suitor has already tried and been rebuffed, and since the Trust still has 80% voting power and a social mission in addition to fiscal oversight responsibility, Hershey will continue to go it alone and make small acquisitions along the way. Frankly, if there’s ever going to be an acquisition of Hershey’s, my best guess for a suitor would be Berkshire Hathaway, maybe the only buyer likely to be appealing to the Trust as a long-term partner (as long as they don’t do it with 3G Capital), and I don’t know whether Buffett would ever be interested (Berkshire has never owned Hershey shares, as far as I know, but made a lot of money from Mars by helping them take over Wrigley about a decade ago).
You never know for sure, though, and Hershey did have a disappointing year in 2017, with relative softness in some of their core business, and they do have a mostly pretty new management team that’s been in place for only a year or two (though the CEO was promoted from within)… and the Trust has been willing to participate in past buybacks that the company has done (including one last summer at $106 a share, which doesn’t look as compelling at the moment), so perhaps the attitude will change. I’m assuming not.
So we have a company built around strong brands, with a plan to expand its presence in “snacks” in general, and a long term record of growing earnings at a compound rate of about 8% a year… and a forecast that the company itself thinks it will keep growing earnings at 6-8% going forward. At that rate, and with a strong underlying brand, the current price sounds pretty good — not cheap, but Hershey has almost never been really “cheap”, at least not in this century… the trailing PE ratio of 19 is as low as it has been since the dot-com crash. I don’t think this is likely to beat the market if we see a continuing bull market in tech stocks drive us higher, but it will probably hold up reasonably well over the long term.
Hershey is not an obvious by on a technical basis, it broke below its 50-day and 200-day moving averages early this year and hasn’t looked back, and it’s arguably “oversold” by most of the technical metrics but isn’t drastically so (on those metrics, frankly, it looked better at $98 in February than it does at $90 today, so maybe we should agree to ignore those). I don’t use technicals, but I do like to take a look sometimes to see if there’s any chart action that’s obviously impact the shares — and I don’t see any here, other than the obvious “investors are not bidding the stock up.”
And there’s probably no reason why they should in any immediate or drastic way, it currently pays a solid dividend of almost 3%, and has been growing that dividend pretty steady for a decade or so, and I’d say it’s reasonably valued, but it’s not likely to double earnings in the next couple years or anything sexy like that, and it won’t be the first stock to surge higher if we have a “melt up” in the market again.
But it’s a steady company that aims to return about 10% to shareholders each year (~8% from earnings growth, led by overseas and new products on top of their slower and steadier core US candy business, plus another 2%+ from buybacks and dividends), and they are committed to a minimum 50% payout ratio (meaning they’ll pay out at least half of their earnings as dividends — they’ve been above that in recent years, but it’s close to the longer-term average). They’ll probably announce another dividend increase late next month, and my guess is that it will probably be in the same ~6% range as the past couple dividend hikes.
If you want to research Hershey, there’s certainly plenty of information out there — in addition to the regular ol’ financials (last quarterly press release is here for the headline basics), I’d suggest starting with their factbook to get a sense of the history, and their recent investor presentation to get a sense of where they think they’re going.
So where does that leave us? Well, it’s not a little See’s Candy and it’s not going to generate the wild growth that Berkshire enjoyed with that acquisition (they bought it for $25 million in the early 1970s, and it has generated something like $2 billion in profits for Berkshire now), but it’s a strong collection of brands and a fairly steady company, and, as Porter says, they are pretty capital efficient despite their investments in expansion and growth in recent years.
You know what? I’ll take a bite. Hershey has never looked cheap in the half dozen or so times I’ve looked at the stock over the past six or eight years… but this is as cheap as it has ever looked, as the wave of pessimism crashes over the packaged foods industry, and that’s something. (I’ve looked at other food companies lately, too, tempted by falling stock prices — but none of them seem to have businesses that are as strong as the candy business, and I haven’t yet been convinced by Campbell or Kraft Heinz or the cereal giants… though Berkshire is my largest holding, so I guess I’ve got plenty of exposure to KHC already). And, frankly, I’ve been looking for a little more exposure to “slow and steady dividend compounding” in my portfolio to balance the more speculative bets I’ve been making… and I have almost no exposure to this broad consumer goods sector, so Hershey is a pretty good fit on that front.
Hopefully Milton was right, and consumers will continue to agree that “chocolate is a permanent thing” … and hopefully the century-old brand that Milton Hershey founded and shared with generations of American families (and later the world) will continue to adapt and evolve as tastes and people change. I buy my kids (and me, but don’t tell anyone) the same Kit Kats and Reese Peanut Butter Cups that I enjoyed 40 years ago, and there’s a certain comfort in that. Even if I do think the unholy white chocolate experiments have got to stop.
That’s just my money I’m talking about, though, not yours — and with your money, it’s what you think that counts. Interested in the boring sweetness of a Hershey bar? Think they’re pushing too hard in buying a popcorn business at 4X sales? Think this is the bottom of a dip, or the beginning of a long decline? Let us know with a comment below.
Disclosure: As noted above, I now own some shares of Hershey in the Real Money Portfolio, and also own shares of Berkshire Hathaway. I don’t own the other companies mentioned, and will not trade in any covered stocks for at least three days, per Stock Gumshoe’s trading rules.