Confectionery giant Hershey(NYSE: HSY) is known for candy coating things, but there's really no way to make a 25% stock drop more palatable. Investors are clearly worried that the company has big problems that will be hard to fix. In some ways that's true, but it doesn't mean that Hershey can't solve the issues it faces. Here's a look at Hershey's situation and why this dividend growth stock is still worth buying.
Cocoa goes to the moon
The headline-grabbing issue for Hershey falls under the category of inflation. In this case the rising price is for cocoa, a key ingredient in making the chocolate for which Hershey is famous. Unlike many other ingredients that consumer staples makers use, cocoa prices haven't started to fall in a material way. So this issue is going to linger for longer. Part of the problem is specific to the production of cocoa, a business that hasn't been supported with investment, is dealing with aging trees, and is facing some crop illness issues.
Image source: Getty Images.
In addition to that headwind, Hershey just updated its distribution system. This created a bit of a wrinkle in the earnings picture because inventory was built up prior to the switch over to the new system to ensure there wouldn't be any disruption to supplies for retailers. That pushed earnings up and, now that the rollout has been successfully completed, those inventories are getting worked down, a move that suppresses earnings. That's a bad look, especially when investors are worried about the rising cost of cocoa.
Then there was the popcorn slowdown, as cost-conscious eaters shifted toward more filling snacks. Popcorn had been one of Hershey's key growth drivers as it expanded from sweet snacks into salty snacks. Or, to put it another way, along with the other problems it faces, popcorn is a growth driver that stalled out.
As if all of that wasn't enough, there is also the big-picture threat posed by new weight loss drugs. The drugs appear to help people lose weight by changing their eating habits. If that trend continues over the long term, there is a very real risk that demand for confections will fall. That could be a problem for Hershey.
Hershey is down, but not out
With that backdrop, it seems little wonder that Hershey's stock has fallen more than 25% from its peak in 2023. But how bad is it? Perhaps not as bad as it may seem.
For starters, cocoa is just one of many ingredients that Hershey uses. While important, the company can make changes to adjust. For example, it has brought out products that simply use less chocolate, more types of non-chocolate treats, and it has adjusted product sizes. Moreover, cocoa is a commodity and always has been. So management is used to dealing with the ups and downs. Price hikes are a normal factor that gets adjusted, and chocolate is still a relatively low-cost indulgence. This won't be an easy issue to deal with, but it seems unlikely to permanently derail the company.
The system update, meanwhile, is just a blip. As the company moves further and further beyond the rollout, the issues it caused will simply go away. And operations, including order flow, should return to more normal trends. (Note, of course, that confectionery sales are highly seasonal, so normal can still be a bit lumpy.)
With regard to popcorn, Hershey is already on the problem. Specifically, it has adjusted package sizes (larger in this case) to enhance the value proposition of its popcorn offerings. This should help get popcorn sales back on track.
The new class of weight loss drugs is a bit more of a wild card. Wide adoption could change buying habits. But people are notoriously bad at sticking to medication regimes, so the long-term impact could be very different from the short-term impact we're seeing today.
Hershey's dividend has grown fast
So it looks like all of the issues facing Hershey today, and there are a lot of them, are solvable or likely to be temporary if you think in decades and not days. Meanwhile, the stock's dividend yield is near the highest levels of the past decade. The 2.7% yield isn't huge, but you have to juxtapose that against the 10% annualized dividend growth the company has put up over the past 10 years. The most recent increase was nearly 15%, which is not the type of increase a company would make if it thought the dividend was at risk.
If you are a growth and income investor or a dividend growth investor, Hershey should look very enticing right now. And if that's not enough, the company's price-to-sales and price-to-earnings ratios are both currently below their five-year averages, suggesting Hershey could also be viewed as a value stock.
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Reuben Gregg Brewer has positions in Hershey. The Motley Fool has positions in and recommends Hershey. The Motley Fool has a disclosure policy.
