High inflation, soaring interest rates, and the war between Russia and Ukraine are just a few of the factors that have contributed to the market meltdown in 2022. These events have led the S&P 500 index 18% lower so far this year.
But amid the market downturn, the consumer staples sector has held its own. For instance, shares of the confectioner, The Hershey Company (HSY -0.53%), have climbed 20% year to date.
With such a magnificent performance in 2022, this begs the question: Is now still a good time for dividend growth investors to buy Hershey's stock? Let's drill down into the company's fundamentals and valuation to address this question.
Tremendous brands are leading sales and earnings upward
Since its founding by Milton Hershey in 1894, Hershey has blossomed into a dominant confectioner. The company's $47 billion market capitalization makes it the second biggest confectioner in the world, behind Mondelez International's $92 billion market cap.
The Pennsylvania-based company's brands include Ice Breakers mints and gum, the eponymous Hershey chocolate, and York Peppermint Patties. Thanks to these iconic brands, Hershey enjoys second place in the U.S. snacking category and first place in the U.S. confection category.
Early last month, the company reported its financial results for the third quarter ended Oct. 2. Hershey's net sales surged 15.6% higher over the year-ago period to $2.7 billion during the quarter.
To compensate for the inflationary cost environment, Hershey implemented price hikes. This contributed to a 7.7% growth in its net sales in the quarter. But because consumers greatly savor the company's brands, Hershey's volumes increased 4.1% year over year for the quarter, demonstrating the elasticity of its products. The company's acquisitions of Pretzels, Inc. and Dot's Pretzels, completed last December, also provided a 4.1% lift to net sales during the quarter.
Hershey's products are sold around the world, and foreign revenue is converted back into U.S. dollars. Given that the U.S. dollar has recently been quite strong compared to other currencies, this explains the 0.3% unfavorable impact to net sales stemming from foreign currency translation in the quarter.
Hershey produced $2.17 in non-GAAP (adjusted) diluted earnings per share (EPS) for the third quarter, which was a 3.3% growth rate compared to the year-ago period. Due to a 24.7% rise in the company's cost of sales, Hershey's non-GAAP net margin dipped 200 basis points year over year to 16.4%. A 0.6% reduction in the company's outstanding share count wasn't enough to neutralize the decline in profitability. That explains how Hershey's adjusted diluted EPS growth lagged behind net sales growth during the quarter.
As the company continues to branch out its product offerings in the salty snack category and further build on its chocolate brands, solid growth should continue. This is why analysts believe that Hershey's adjusted diluted EPS will grow at a 10.6% rate annually over the next five years.
Image source: Getty Images.
A market-beating dividend with tremendous growth potential
Compared to the S&P 500 index's 1.6% dividend yield, Hershey's 1.8% yield is still pretty sweet. This is especially the case considering the company's dividend growth potential.
Hershey's dividend payout ratio will clock in at around 47% in 2022. Since the company is retaining the majority of its earnings to reinvest in future growth opportunities, repay debt, and repurchase shares, it should have little difficulty generating significant future growth. And because the payout ratio has some room to grow, annual dividend growth could slightly exceed earnings growth moving forward. That's why I am expecting annual dividend growth of 11% to 12% over the next few years.
Hershey's stock is still worth it at this valuation
Hershey is a world-class business. And based on its valuation, the stock looks like a decent buy at this point.
Hershey's forward price-to-earnings (P/E) ratio of 26.1 isn't that much more than the confectioner industry average forward P/E ratio of 23.7. Thus, the stock remains a compelling buy for dividend growth investors.
