Dueling Fools
Hershey My Way
August 25, 1999
The Bear Rebuttal
By
Normally, when I write one of these Bear takes for a Duel, I pull out the figurative sledgehammer and just start swinging wildly at anything and everything about the company in question. I didn't do that here. In fact, I went so easy on Hershey in the opening argument that there's a pretty high degree of overlap between what I wrote and what Paul argued; we see the same company here.
However, when it comes to valuation, my fellow Fool gets a little greedy in my opinion as he casually slides in the following assertion: "That means that as of this writing Hershey's is trading at about 21x forward earnings, a discount to the average stock in the S&P 500. I think Hershey has a little room for multiple expansion given its quality of earnings."
Hershey deserves multiple expansion because of the quality of its earnings? Woah. All of a sudden, I feel that need to pull out the heavy-weighted slug and the truncated super-cissoid (see Steve Martin's The Sledgehammer: How It Works if you're at all confused), because now I see some "stuff" that really deserves to be "wanged" here.
The price-to-earnings multiple on Hershey's has already expanded from a tight range of 12-19x earnings between 1989 and 1993 to over 25x, and yet Paul wants more? I don't want to oversimplify too much here, but the reason that Hershey is trading at a P/E discount to the market is because its earnings aren't exactly growing as fast as the average company in the S&P 500. The real growth rate here is about 5% annually if you're measuring in terms of net income or sales. Sure, to the casual observer who is fixated on earnings per share, Hershey appears to be growing a little faster than that, but that's strictly because of the all the shares that Hershey has repurchased.
Now I salute that buyback. When a company doesn't have a way to reinvest earnings into its business in a way that produces an acceptable return on invested capital, then getting that money back to shareholders in the form of dividends or buying back shares makes a world of sense. Even when a company takes on several hundred million dollars in debt to buy back those shares (as Hershey has done) and reduce its weighted average cost of capital, that can still make a lot of sense. I think that Hershey is doing the best that it can with a tough situation.
But don't get confused about what this translates into. Hershey doesn't have many places to invest new capital -- it isn't really a growth company, so it definitely shouldn't command a higher P/E than the S&P 500's average.
You can't look at a vaguely solid 5% annual growth rate and say that that should command a premium to the market's more inconsistent 10-15% growth rates. The consistency really doesn't have that much value, and evened out over the course of long periods of time it has no extra value at all. By the way, Hershey's earnings growth isn't all that consistent in the first place. Hershey's net income is going to be down this year (primarily due to the sale of its pasta business), and isn't expected to be very much higher in 2000 than it was in 1998. So I'm not sure that I can sign on to this "quality of earnings" that Paul refers to.
Sensing that Hershey isn't exactly undervalued, Paul asserts, "Even if Wall Street doesn't bid Hershey's stock up in value, investors have the juicy dividend that Hershey pays out. As I'm writing this, the stock yields 1.9%, which is fairly hefty by today's standards and sweeter than a Hershey Kiss." That's some concession. This stock really may continue to languish for a while -- after all, it's the same price today that it was going for nearly two and a half years ago. Do you suppose shareholders are actually satisfied with the less than 2% annual dividend they've pocketed over that time period? Really?
Hershey may be the brand of choice at Halloween, but potential shareholders are far more likely to be tricked than treated by purchasing at today's price.
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