The U.S. inflation rate reached a 40-year high of 7.5% in January, which was due to a variety of factors. This, unfortunately, makes the present a difficult environment for retirees to preserve their purchasing power.
The good news is that top-notch dividend stocks often grow their payouts to shareholders in excess of inflation. One such stock that has a reputation of doing this is Hershey (HSY 0.40%), which has raised its dividend for 12 years straight.
But can Hershey's healthy dividend growth continue going forward? And is the stock a buy for income investors? Let's take a look at Hershey's fundamentals and valuation to address these questions.
Image source: Getty Images.
Brands with pricing power will drive future growth
Hershey closed out 2021 with a fourth quarter that exceeded analysts' expectations for both net sales and non-GAAP (adjusted) diluted earnings per share (EPS).
Hershey reported $2.33 billion in revenue during the fourth quarter, which works out to a 6.4% growth rate over the year-ago period. This easily topped the analyst consensus of $2.26 billion in revenue for the quarter. But how did Hershey beat analysts' revenue forecasts for the eighth quarter out of the last 10?
Hershey's net sales growth was primarily the result of list price increases across all of its segments for its well-known brands like the flagship Hershey chocolate brand, Reese's, and York peppermint patties. This accounted for 6.1% of Hershey's year-over-year net sales growth.
Because Hershey's products are consumed by millions of customers around the world every day, the company has a great deal of pricing power. Within reason, customers are willing to pay more for Hershey's brands because they prefer them.
Despite Hershey's price hikes and fewer shipping days in the quarter, this only led to a 2.1% decline in sales volume. This was more than offset by a 2.2% year-over-year increase in sales stemming from the company's recent acquisitions of Pretzels and Dots, as well as a 0.2% benefit from favorable foreign exchange translations.
Moving down the income statement, Hershey recorded $1.69 in adjusted diluted EPS during the fourth quarter. This represents a 13.4% growth rate against the year-ago period and bested the average analyst estimate of $1.61. So, how did Hershey surpass analysts' adjusted diluted EPS predictions for the ninth quarter out of the past 10?
The answer is a combination of two factors: An 80-basis point year-over-year improvement in Hershey's non-GAAP net margin to 15.1% in the fourth quarter, and a higher revenue base.
And thanks to Hershey's solid fundamentals, decent growth should continue in the years ahead. In fact, analysts anticipate that Hershey's earnings will grow at 9% annually over the next five years.
A goldilocks payout ratio
Hershey's fundamentals aren't the only factor that should lead to inflation-crushing dividend growth. The company also has an optimal dividend payout ratio.
Hershey's dividend payout ratio last year was 47.4%. This enables the company to retain as much capital for future acquisition activity, product launches, share repurchases, and debt repayment as compared to what it directly pays out to shareholders.
Hershey's upper-single-digits annual earnings growth potential and perfect payout ratio should translate into at least 8% annual dividend growth potential for the foreseeable future. This is basically in line with its 10-year annual dividend growth rate of 9%. Paired with Hershey's market-beating 1.7% dividend yield, this makes it a nice dividend growth stock.
The company's financial condition is respectable
Another reason to consider buying Hershey is its financial footing.
Hershey's interest coverage ratio improved greatly from 11 in full-year 2020 ($1.64 billion in earnings before interest and taxes (EBIT)/$149 million in interest costs) to 15.1 in full-year 2021 ($1.92 billion in EBIT/$127 million in interest expenses).
Hershey's EBIT would need to plummet nearly 95% for the company to become insolvent. Given the company's steady earnings growth in just about every operating environment, the probability of such an event occurring is quite low.
Hershey is a safe haven stock
Hershey's stock has performed impressively year to date, which supports the argument that the stock is one that investors flock to in times of uncertainty. For instance, Hershey's stock has increased 8% year to date, while the S&P 500 has fallen just as much during that time.
Even with Hershey stock's recent outperformance, it doesn't look to be significantly overvalued. That's because Hershey's trailing-12-months price to free cash flow ratio of 27.3 is only a bit above its 13-year median of 24.7. For a company whose fundamentals are as strong as ever, Hershey appears to be a buy for income investors looking to both preserve and grow their dividend stream.
