Value Investors Tribe

Analysis Date: November, 2023

For the analysis of any business, I use the framework described by Warren Buffett in 2007 letter to shareholders. Warren Buffett looks for four parameters particularly: a) Understandable business economics b) Long-term growth prospects c) Able and trustworthy management d) A sensible price tag.

Business Economics and its Moat

Hershey’s is a leading global confectionery brand which sells under 90 brand names in 80 countries. Hershey’s chocolates and other confectioneries have become globally well-known and enjoy healthy market share in United States. It has also entered the salty snacks business in recent past and that business has been growing healthily. One of the most important characteristics of a wide moat is when the business name/brand becomes a brand. Hershey’s has become a replacement of chocolate in multiple households. Additionally, Hershey’s has licensing agreements of various popular brands such as Kit-Kat, Cadbury and others to sell their products in US as well as for some brands globally. Hershey’s has been successful in positioning itself as a globally available, consistently tasting and pocket-friendly chocolate brand which is in operation for over 100 years. Bolstering this great brand name which helps in pricing power is the wide distribution network which Hershey’s has set up globally which helps in inventory management. There are some fluctuations in the margins and other financial metrics which are primarily due to commodity nature of raw materials like sugar, cocoa etc. The business has significant experience in how to navigate the temporary waves and hence its moat is not in danger.

Growth Prospects

Hershey’s has grown revenue by about 5% for the past 10 years, net earnings by 10% from 2012 to 2022. Higher growth of net earnings compared to sales represents efficient operations as well as pricing power. Additionally, the business requires only 33% of its net earnings for the capital expenditure leading to free cash flow growth of about 8%. The growth rates might not seem impressive however the primary reason is business’ venture into salty snacks business and some other acquisitions done in recent past. The extraordinary return on equity and high return on capitals helps in running operations without much debt. The chocolate being a recurring purchase and the Hershey’s being a popular brand with pricing power, the earnings and cash flows are expected to grow.  

Management Trustworthiness

The CEO Michele Buck and other managerial executives have been with Hershey’s for over 5 years (some even more). This might seem lower compared to some other businesses however the chronology of how the management has changed over the 15, 20, 25 years seems reasonable and what a reasonable board would do. Annual reports, earnings calls and other supporting materials are presented with candor, the attempts are made to explain the business and not sell the investment opportunity. Management has accepted and addressed the challenges business has faced in the past and is cautious of the challenges that can be a reality in future.

Valuation

Historically, the net earnings have grown at 10% and free cash flow has grown at 8% from 2013 to 2023. For the Discounted Cash Flow analysis, free cash flow growth of 6% over the next 10 years was used which makes it conservatively rational assumption and a terminal growth rate of 3% is assumed. Given the long operating history of the business as well as the efficient operations, the business can access capital at relatively lower cost. As a result, discount rate of 7% is used which is slightly higher than the risk-free rate. DCF Analysis is shown in the table below.

• Sum of Present Value of FCF (million $): 17139.1
• Terminal Value (million $): 78698.9
• Present Value of Terminal Value (million $): 40006.5
• Total Equity (million $): 57145.6
• Shares Outstanding (millions): 204.30                                                                                                                          
• Intrinsic Value (per share): $280
• Current Trading Price: $193
• Margin of Safety: 31%

What does this mean? This implies that based on our DCF assumptions, Hershey is currently undervalued with its intrinsic price somewhere around $280.

Disclaimer: This fundamental analysis of Hershey is primarily for educational purposes so as to help value investors learn core concepts. This is not a buy or sell recommendation of any form whatsoever. Reader discretion is advised.