Revisiting Hershey: The Market Pays What the Market Bears

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Following brief upward momentum after we first bought Hershey, the stock proceeded to slide downward. Cocoa prices remain elevated, and there is significant uncertainty surrounding the short-term impacts on the company's operations. However, Hershey's recent earnings report shows that the company is more resilient than it may appear.

Despite a 20% stock decline, Greg emphasizes that there are still many things to like about Hershey. Simply put, there is much more to the story than the current price of cocoa. Going a bit deeper, Greg examines the cocoa supply chain, specifically the impact of weather and geopolitical issues on production in major countries like Ivory Coast, Ecuador, and Ghana, highlighting several factors that suggest a possible future drop in cocoa prices. He further discusses Hershey's superb hedging strategies, strong balance sheet, and potential for high returns through dividends and stock growth within the next decade. Ultimately, Hershey's attractive valuation, dividend yield, and potential dividend growth allow investors to start with an advantage. In closing, Greg presents a Suber Bowl analogy to underscore the patience required for long-term investing, contrasting it with the short-term focus prevalent in current market analysis. 

00:00 Introduction to The Dividend Mailbox

02:16 Revisiting the Hershey Story

05:37 Hershey's Market Position and Challenges

07:36 Cocoa Market Dynamics

12:04 Hershey's Financial Health and Strategy

15:29 Investment Strategies and Long-Term Outlook

25:50 Rant on Market Commentary and Short-Term Thinking

31:14 Super Bowl Analogy and Final Thoughts

37:50 Conclusion and Contact Information

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Transcript

[00:00:11] Greg Denewiler: This is Greg Denewiler, and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth.

Welcome to episode 44 of The Dividend Mailbox. Today, we're going to revisit a story that we first brought up in episode 35. Here's the great news, the stock has gone down about 20% since we first brought it up. But as we look at it and continue to build it out, we are more and more committed to it. So you probably will want to listen to this entire episode because the rant is coming later on, and you will have a pretty good idea by the time this episode is over of why we love the fact that the stock has gone down 20%. Also, when we first started recording this podcast, The Super Bowl had just concluded and I did have a little kind of an aha moment personally, so we'll see if you can make that connection. But before we get into this episode, we would like to bring your attention to not only do we do podcasts, but we also do a newsletter. It's called Observations On The Markets. We try to religiously keep it to only one page. It does come from a little different slant, it's more of looking at the markets and topics that seem relative at the time. So feel free to look at the link and our show notes, if you want to check out our newsletter. Hopefully, you could get something from that. So with that, we're going to revisit the Hershey story.

Everybody knows what Hershey does. Now they do have a pretty diverse product base. They've got about a hundred different products that they're involved with. Reese's is still their biggest brand, but they also have Twizzlers, Pretzels, they have York, they have Skinny Pop, they have a lot of different versions of chocolate, Ice Breakers, etc.

Hershey has been around for 130 years, and one of the first thoughts you may be thinking, I don't really want to hear about another boring company, because I'm here to try to make money. Well, before you totally dismiss the fact that these are not high growth companies, they're just consistent growth companies, when you look at the S& P 500- I'm going to throw one statistic out and then we're going to go into it a little bit more later- but if you would have put $10,000 into Hershey in 1989, you now have $420,000. In the S&P 500, total return on both of these numbers, you now have $360,000, so it's beat the S& P 500. From 1989 to May of 2023, which happens to have been when the stock hit an all time high of $275, at that point, your $10,000 is now worth $705,000 versus $239,000 for the S&P 500. So maybe it's not such a boring story after all.

But now let's move into Hershey, you know, go back and listen to episode 35 if you want kind of the base of it, we're not going to go back and tell that again. When we first bought the stock, it was in the $180s. That was the first position we took. A couple of months later, it did rally up to $210 and basically that was under a potential acquisition, but for reasons I don't want to go into right now, that didn't really go anywhere. Since then, the stock basically has been in decline. We started with a small position because to be honest with you at the time, and even until recently, the stock wasn't cheap. It just got cheap enough to where we thought it was a relative value and over a 10 year horizon, we felt like the return was there to start buying it because management just has an excellent track record of creating shareholder wealth over time.

Well, as it's come down, we have put more money in it and we continue to add to it as it goes lower. As of this run on the recording for this episode, right now, the stock's around $157. It had gotten down into the low $140s just last week. However, since the recent earnings report, the stock has actually bounced back up by more than 10%.

So, you know, the stock has come down quite a bit, and one of the questions is, why? This kind of comes back to which game are you trying to play here? And if you're trying to get a good company at a good price or a great company at a reasonable price, you have to have something that's not going too well, because that's the only way the market is going to start to discount it somewhat.

If you remember the story at all, one of their key costs of goods sold is cocoa, and the price of cocoa in the last few years normally trades around $2,000 a ton. Recently, it's gone up over $10,000 a ton. Actually, it's it's been plus or minus in that area for a while, for a year or more. It isn't too hard to make this story make sense because in 2023, the price of cocoa begins to climb and that's the same period when Hershey starts to run into problems with earnings growth. When you have cocoa prices go up five times, what are you going to do, raise a Hershey bar from $2 to $10? You're probably not going to sell very many of them, it's a very difficult environment. 

Well, how much does Coco play into this currently? Is it the whole story? No, there is a piece of it that's probably in health and sugar. There is a lot of publicity out there right now on that topic. But overall, knowing what's going on in the cocoa market and what it takes for it to revert back to the mean is definitely something that if you're going to own Hershey and you're going to hold it for a while, that's an answer that you should definitely have.

One of the first things to know about cocoa, it is grown in a relatively small region. It's only about 20 degrees north or south of the equator, and even from that standpoint, it's only grown in a few countries that really focus on cocoa's production. In 2023, Ivory Coast exported about 42% of the global supply of cocoa. That was followed by Ecuador and Ghana, both of those came in at around 15%. Nigeria exports around 8.5% of global supply. So you've got just a few countries that are major players in the cocoa industry. If you didn't notice, some of these are not exactly politically stable places to live. 

So to make matters worse, weather obviously can have a tremendous impact on a crop's production. There's been a drought that's lasted for a few years. It was mostly the result of an El Niño. That warms up the ocean and it changes the pattern of the jet stream, which has a huge impact on rainfall, and that's what's happened in West Africa. The good news, if you're looking for lower cocoa prices, that weather pattern is now shifting. As the ocean starts to cool down a little bit, we're going back to the La Niña. That implies that we're going to have a wetter climate in West Africa. You don't know exactly when, there's a lag, it takes a while, but the real challenge is you can't wait until the weather shows up to buy Hershey. The markets are always predictors of the future. By the time you see something, a lot of the value is already gone. So this is a simple case of look, weather patterns change and there are reasons for it, and in this case, we're just trying to get out in front of the curve and use it as a buying opportunity.

So then you might ask yourself, “Well, okay, if everybody knows this- if everybody knows the weather patterns will eventually change, then why are cocoa prices so high?” The simple answer to that is, first of all, if you go farther out in the futures market, they're not at $10,000 per ton, they're actually lower than that. Right now, they're down around $8,000. So they're already anticipating some weakness in cocoa longer term. But if you need cocoa and you need it today, you have to buy it today. So if there's a shortage in the short term, the market has to pay what the market can bear. But the good news is, one of the common sayings in regard to commodity prices is “the best cure for high prices, is high prices,” because it incentivizes you to go out there and plant a lot more cocoa. The growers are trying to capitalize on that high price, and as they start to increase their crop size, that brings more supply into the market. At the same time, those higher prices have lowered demand. You've got more production coming online and you got lower demand. What does that do? That just starts to bring the price down. Eventually it normalizes and commodities are known for going to both extremes. 

What happens in the entire space, it's the whole inflationary problem that the whole world has had here for the last few years. Hershey's raised prices roughly 4%, and the next few years, they tend not to cut those prices back. The price increases stick. If the commodity price comes down to $3,000 a ton or even $4,000 a ton, it's just a recipe to potentially even beat the estimates on the upside. 

Why we really like this story more and more is, okay, so let's look at how did the price of cocoa actually impact Hershey? The earnings that were released last week, in our opinion, they've really managed this environment extremely well. Basically earnings have held up well today, partly because Hershey has a great hedging program. And there's actually two parts to this. One, they have a great hedging program and two, they have a lot of contracts with growers and the price at the grower level can be different than what's on the futures exchange. A lot of times their pricing is better when they're buying it directly from the growers. So that's the first big positive. The second thing is they are still hedged fairly substantially through 2025. That offers them some support. And you also can't forget that there are multiple ways to hedge, meaning that you're trying to lock in a price so that in the future, if the price has changed dramatically, you already know what you're going to pay. Another way to hedge is just to find a substitute. Instead of cocoa, maybe find a different form of mixing it with something else where you still get the taste, but you don't use as much of it, or even find in a substitute where the consumer actually likes that as a replacement and they don't have to pay as much for it. This company is really well managed they're considered to have one of the best hedging programs in the whole space of Cocoa, but it's not hard to figure out, they've been there forever and they are a big player. 

One of the things that we've done, we've assumed, okay, what if they didn't have any hedging at all last year? Well, they had net income of about $2.2 billion. They had a hedging gain of almost $500 million. If you take that out, you get their net income down to about $1.6 billion. With slightly more than 200 million shares out, that means that they would have earned a little less than $8 a share, even without the hedging. 

If you look at how management has managed the balance sheet, you've got debt to equity now that is down, as of the report that just came out a few days ago, for the fourth quarter and for the full year of 2024, you’ve got debt to equity that's now down to about one to one. That is the lowest debt to equity ratio since going all the way back to 2004. The balance sheet is well positioned moving forward. Shares outstanding is down to about just above 200 million. They have not had to issue more shares even though they have done some acquisitions to try to broaden their product base where it's not totally dependent on chocolate anymore. Even in this extremely difficult market, they have cashflow to buy back % of their stock, not a big number, but they are buying it back and it's cheaper than it's been in a long time on a valuation basis. They also are paying down debt. This company is as healthy or healthier than it's been in a long time.

So as far as taking a position in the company, it's like, okay, the stock's been coming down, there's two ways we can look at this. We can look at it as, okay, we were early. We should have waited before we bought any of it. Or the other way to look at it is, the lower this thing goes the more we're going to buy. And as it gets down to when it was at $140 last week, the stock had a dividend yield of 4%. If you buy for a long term hold, and if you've listened to very many of our podcasts at all, you know we basically try to have a 10 year time horizon minimum. With a 4 percent yield, the company doesn't have to grow. You've got 40% of your money back in a decade. And if you just throw in a little bit of compounding in there, earning interest on interest, basically you have a 50% return and nothing has to happen. When you start with that kind of an advantage, good things can happen to you pretty fast.

Again, I do not want to leave the impression that we're experts on the cocoa markets. However, we have been probably more than just a casual observer to try to figure out whether this is more of a short term phenomenon or whether it's more of a permanent shift. Well, right now everything seems to point that eventually cocoa prices are going to come down. The current industry consensus estimates for cocoa production, from what we have seen, is that they are estimating that over the next year, exports will probably increase about 11%. But of course, the markets are the markets, and that is just a forecast. So because of weather production, what Hershey and other companies are doing to try to hedge themselves or to create ways to get more cocoa into the market, everything seems to point that in the next year or two, this should start to normalize. It seems that how they've been dealing with such a dramatically affected market with high prices, that they're really set up to maybe outperform as things normalize. 

Well, if you look at value line, which we use as just a guide, but they actually predict that it's an 11% dividend grower out to 2027. If you have 11% dividend growth- which is not too far off what the company has done in the last decade, just below 11%- that means your 4% yield in 10 years, if the price of the stock stays the same, you're now gonna have a company that is paying you an 11% yield. That means the likelihood of the stock price being higher is pretty high, plus you've generated a ton of cashflow. Value line thinks the dividend growth is intact, and they've got earnings estimates out to 2027 of $12 a share. If that actually happens, the odds of this stock being down here is pretty slim, although there's never a guarantee.

Let's just look at this from one other aspect. We want a minimum hurdle of 7% dividend growth. Right now the dividend is $5.48 and they are due to bump it coming up here pretty soon. I will just throw out a quick note on that. I wouldn't be surprised if this bump this year because of the challenges they've had in the commodity space that they may not bump it quite as much this year.

If they grow it by 7%, then by 2034, you've got a dividend up to $10 a share. Basically the dividend doubles. That's our hurdle rate. If you use the same 3.5%- which is basically where the stock is trading now, based on its dividend yield- a $10 dividend means that the stock would trade at $287. Including the dividends that you've accumulated over that period of time, you have a 130% total return, and that doesn't even account to compounding, which compounding is going to have a significant impact in here. So that's if the dividend just grows by 7%. 

Well, let's go backwards one step. Let's look at what is the minimum dividend growth we need to hit our target, a minimum of 100% total return in 10 years. That means that we only have to have a 5% dividend growth. And if the dividend stays at 3.5% in 10 years, we've got a 100% total return. The dividend didn’t quite double, but we've had share growth on top of that. 

Now let's go to the other side: What good can happen here? If value line is correct, and this company grows its dividend by 11% for the next 10 years and a dividend yield stays at 3.5%, 10 years from now, you’ve got a return of 212%. It's more than double. If the dividend yield drops down to 3%- which another great thing about this story is normally the stock trades at a premium to the market, and right now it is not. That means the dividend yield is highly likely to decrease from where it is right now. At a 3% dividend yield, now the return is up to 255% on a total return basis. It's not too hard to get to a point where this could be a triple in 10 years. 

And I have to tell you, when you look at, you don't have to worry about technology, about some kid in a garage somewhere comes out with something new. There's a new chip, AI. I mean, the story goes on and on about all the changes in technology. I view this as a pretty attractive story. Now, is there competition in the chocolate world? Absolutely. Hershey's been around for 130 years. They're constantly trying to come out with new products and work in the space. Their market share has basically been holding. They are working towards lower sugar type products, but I will tell you the good news here, chocolate's considered a treat. There's probably a few people out there that use it as a main food group, but the reality is if you eat a little chocolate every day, no matter how much sugar is in it, it's probably not going to have a huge impact to you. You got other things to worry about what you eat. That's the good news there. 

Tariffs are obviously a hot topic now, and in Hershey's case, 91% of their sales are in North America. They can be impacted, but it shouldn't be to the extent that the average S&P 500 gets half its revenue from outside the country. But in this case, Hershey is probably, I mean, I'm not going to call it a hedge to tariffs, but you shouldn't have too big of an impact. The story in our opinion is pretty sound. 

So we actually like the fact that this stock continues to decline. And you might ask, well, why are you not all in it right now? Well, the stock has come down, it's reasonably priced, but we don't consider it really dirt cheap yet. The earnings yield is a little over 5%. We like to target around 6 or 7%. That's what we consider a decent value. And just looking at Value Line's estimate, if they earn $10 here in the next year or two, it's 6.5%. $12 in a few years, it's up to almost 8%. The goal is that your earnings are going to increase over time. That means ultimately you've got upside in the stock if it's valued the same. That's one of the reasons why we are accumulating it. If you get above 7%, in our view, we're starting to get into, it's becoming cheap, but the problem there, then you got to look at, well, why is it cheap? Am I missing something here? 

Our position is probably a little bit more than half right now, and the lower it goes, the happier we're going to be because that's how you create wealth. 

One last thing I'm going to leave you with is- back to buying boring stocks. I gave you an example at the beginning of the podcast of going back to 1989. Well, let's just go back to 2000. The last 24 years, you put $10,000 into Hershey, currently, it's worth $114,000 versus the S&P 500 that's at $65,000. If we take Hershey through May 23, which is really the high, Hershey over 24 years had outperformed the S&P 500 by $195,000 versus $43,000. That is a huge number in a fairly boring story.

Now, here's the great part of this story. In the last one year, Hershey's $10,000 is now $8,000, but the S&P 500 is $12,000. So that is what I call an opportunity. We're willing to be patient and unfortunately we're willing to be early, but when you've got a 3.5%, 4% dividend yield, depending on where you buy this thing at the moment, you get paid while you wait. Not only do you get paid, but you're probably going to get a raise while you wait. 

But now, I'm going to start to move into a little bit of a rant. We try to follow what's, you know, what's being said out there on some of the things that we hold, because we're looking for ideas as far as, well, what did we miss or where's maybe some risk that we didn't pick up? There is then somebody who's been making some comments on Hershey recently. And just last week, this person basically upgraded the stock from a sell to a hold. One of the things that was brought up was, yeah, Hershey is at a seven year high for its dividend yield, which makes it an attractive entry point. But in this person's opinion, you still needed to be cautious about it because the price technically has been so weak. So, there very well could be some more downside here. Technically just means that, looking at momentum indicators and everything, that there just really isn't any real catalyst in the charts and the price action.

So this person brought up the idea of let's do a collar on it because that will help limit some of the risk on the downside. If they continue to struggle and there is always a chance that cocoa prices don't go down right now, in fact, maybe they could even go higher. You just don't know. That's the nature of the commodity business.

Well, here's the thing I find fascinating. So, basically what a collar is, we're just going to keep this simple. The stock's at $100, which obviously Hershey is not, but this is just an example. The stock's at $100. You buy a put, which gives you the right to sell the stock, and let's just say for the next three months at $95 a share. Since that costs you something, it's basically an insurance policy. You turn around and go out and sell a call. It says somebody can buy it from you at $105. So the net result of that position is you can make money from a $100 to $105. You've got the insurance that you can't lose more than the stock going down 5% or going to $95 and you get to collect the dividend. It's an attractive strategy if you wanna just try to generate an income over the next several months and you don't think a whole lot's gonna happen. 

Well, here's the problem. Number one, markets, they don't go up 2% a month or half a percent a month, and at the end of the year, they're up 10%. They tend to have dramatic moves up and down both ways, and a lot of times you get your gain over a relatively short period of time for a while. If you have a call written on it, you're done. If you think your stock over the next 10 years is going to go up potentially 200%, well, you're gone. You're not even in it anymore. At the very minimum, if you want to go back, turn around and go back in it, and the story has improved, now you've got to buy it at $125. You just gave up some of your upside.

So what my point is here, you got to really be careful. There's too big of a culture right now that's built around really looking at investing as a form of entertainment. They're giving you lots of content. They're making comments, some of them every day, trying to come up with what's going on in the marketplace. And of course, they're all experts on “the feel and tone of the market, what's the market telling us right now” It works great if you're trying to figure out how to trade over the next month or two. But if you're trying to create long term wealth, I don't see where this stuff does you any good at all. It probably hurts you because you've got to be really careful of losing focus on what your overall goal is. And I guess that's one thing that you got to really think about. 

Hershey just becomes the prime example of this. If you're looking for a long term compounding of your dividend income, creating a situation where you've got a 200% plus return over the space of 10 years, you don't care what happens in the next two months.  Literally, you don't care at all. And as long as the story is there, you keep playing it. One of the favorite statistics that I love is Warren Buffett created 99% of his wealth after the age of 65. It just takes time. You have to be patient. Patience doesn't happen in the space of a few months or even a year or two. It just takes time. 

And that's going to lead me into another thought that I've, that I don't know, really clicked for me. We'll see if it works here. I’m not a huge football fan, I’m casual observer. Since we're in Denver, The Dividend Mailbox is recorded in Denver. In the past, Denver's had some great football teams, not so good for a while. One of their big rivalries was Kansas City. And even though I'm originally from Kansas, moved out here in my early twenties, I am not a Kansas City Chiefs fan. In fact, I'm kind of tired of hearing how great they are. So I had a little bit of interest in watching the Super Bowl and was, unfortunately or fortunately, depending on which side of the fence you were on, I was glad to see Philadelphia win. 

But not being an avid football fan, more of a casual observer, it's like you look at the whole Super Bowl environment and the culture, I mean, the money that's behind all that is just beyond incredible. It's hard to even imagine. And then you look at Sunday when the game was played, the pregame show started at 11 o'clock. The actual football game in Denver started at around 4:30pm. And it goes on for four hours because of all the commercials and the long halftime show. It's just one big entertainment and it's very easy to say, you know, this is totally absurd. 

Well, the great news about capitalism- and this is the part where this is going to tie back to investing, I think in a pretty significant way, hopefully. Yeah, there needs to be regulation, but  Mahomes makes right now about $50 million a year. Well, guess what? You know, people are willing to watch. They do watch. I mean, unless you're just not a sports fan, the Super Bowl just kind of captures everything for a few weeks and especially going up into the last few days, I think it's the biggest event that's bet on. Part of how I tie this back is, one thing that people forget, they watch this game and they see these two teams play and they think it all happens on one day. Well, guess what? Mahomes probably started playing football when he was five years old. What people seem to forget is these guys practice, practice, practice. They get hurt. They get traded. They don't even know if they're going to make the top team originally, or they lose.  It's a long journey. One day they show up and there they are playing in the Super Bowl and not very many people get there. So the point that I find extremely interesting is I would wager that most people out there, if they were told you can make $50 million, but you have to wait 15 years before you're going to get it and here's what you're going to have to do to get it, I would wager most people won't even do it. And that's the problem in investing. 

In my opinion, it's just too, we want it right now. We don't want to pay the price. And the problem in football, which investing doesn't have this problem, anybody that's making those huge salaries 10 years from now, it's pretty much gone because their identity is going to have to shift to something else. They're not going to be playing football when they're 45 years old. And in the world of investing, as Warren Buffett found out, you can only get better and better and better. It's a great position to be in. My rant about the social influencers and this whole, “We want it now” creates opportunities if you're a long term investor. 

In the world of football, they make a lot of money and you can say, “Well, they don't deserve it.” Well, you know what, you watch, most people watch, and that's what the market pays, so that's what it bears. It's the same thing in investing.

So as we wrap up our Super Bowl analogy and just looking at digging a little further into the whole Hershey story and the price of cocoa, I hope that you realize that a big piece of this is really simply what game are you trying to play? If you're looking for short term performance and keeping up with the S&P 500 over the next quarter or year, Hershey may not be the place for you to be. In fact, the whole dividend growth story- every investment style, including Warren Buffett, comes in and out of favor. So it is beyond extremely important to know, are you trying to play football in the NFL or are you just looking to be a high school athlete and then move on later? Athletes that actually make it to the super bowl are very dedicated. They have a lot of discipline and they are relentless and what they're trying to do. They know exactly what game they're trying to play. They're not changing their story up, they are just relentless. Really investing is, on one degree, the same principle. So as we look at cocoa and Hershey and the whole story that we've developed, from my standpoint, I love situations like this because it's not too hard to connect the dots. That's what keeps you in the game when it's not going so well. We think that the fact that the company has been able to deal with this as well as they have is a major point down the road where we think these guys can get back on track. It can actually exceed our expectations going forward.

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit growmydollar.com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email Ethan@growmydollar.com. Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.