When you can purchase a great company at a fair price, it is often a good time to buy. When the price tag looks cheap, it can be a great time to buy.
Confectioner Hershey(NYSE: HSY) looks somewhere between fairly priced and cheap. Don't miss the chance to buy it because of a little near-term uncertainty. Here are three big reasons to jump at the chance to own the stock today.
1. Hershey looks like a bargain
Every business rides along a sine curve, with good times followed by bad ones, and vice versa. Right now, Hershey is dealing with a few problems (more on that below), and investors are downbeat on the stock. If you are a dividend investor who thinks in terms of decades and not days, this is an opportunity. Some numbers will help prove that out.
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Hershey's price-to-sales ratio (P/S) is currently around 3.8. The five-year average for that valuation metric is 4.1. The company's price-to-earnings ratio (P/E) is 22.5, versus a five-year average of 25.5. Clearly, based on more-traditional metrics, the stock looks attractively priced.
But don't stop there: Its dividend yield is around 2.7%, which happens to be notably higher than its five-year average of 2%. If you have ever looked at Hershey stock and thought, "If only it were cheaper," well, it is cheaper right now.
2. Hershey's business is getting better even if its earnings are hard to read
One of the things that is interesting with Hershey today is that it has been making upgrades to its distribution system. But these come with risks, particularly for the company's retailers, which rely on it for products.
If the rollout of the new system doesn't go well, customers could end up without the inventory they need. Thus, retailers built up inventories ahead of the switch over to the new system, which boosted sales. The new system is working fine, but retailers are working down the inventory they previously built up, and that's now depressing sales.
This isn't exactly good news, but neither is it really bad news. It's more of a necessary blip in the process of improving the business over the long term. In other words, don't read too much into the company's earnings right now even though sales fell over 16% year over year in the second quarter.
There's another wrinkle in that number. About 9 percentage points of the drop were related to the system upgrade. The other 7 percentage points were tied to the seasonality of Hershey's business. Confection sales are heavily influenced by holidays, which can shift between quarters. So the numbers look extra ugly with the double hit, but there's likely no reason to be worried.
3. The biggest headwind is cocoa
The one negative that investors should monitor closely is the price of cocoa, a key ingredient for chocolate. There's an element of general inflation to the massive price spike that has taken place, but there are also fundamental reasons why cocoa prices might have stepped into a higher range (including aging crops and plant disease). This will affect Hershey's earnings. Just how bad is it? Cocoa is trading near all-time highs.
But people love chocolate and have historically been amenable to paying higher prices for this relatively low-cost luxury. Over the near term, Hershey believes it will be able to pass through price increases of around 6% to 7%.
That said, the plan isn't to pass through all of the cost increase right away. Instead, management wants to take it slowly, accepting a temporary hit to margins as it eases in price increases over time. That seems like a prudent way to deal with the issue.
Given the company's long and successful history, it seems logical to give management the benefit of the doubt and view the concern here as yet another reason to take a contrarian stance with the stock.
Out-of-favor Hershey could be a tasty treat
If Hershey were firing on all cylinders today, it wouldn't be on the sale rack. But if you can look at the long-term history of the business and its stock and recognize that this downturn is likely to be temporary, then now is the time to jump aboard. That's particularly true if your time horizon is long.
Should you invest $1,000 in Hershey right now?
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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.
