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Home›Debt repayment›Is this dividend growth stock a buy?

Is this dividend growth stock a buy?

By Paula Torr
March 7, 2022
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The inflation rate in the United States hit a 40-year high of 7.5% in January, 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 blue chip dividend stocks often increase their payouts to shareholders beyond inflation. One such stock that has a reputation for doing this is Hershey (HSY 2.25% )which has increased its dividend for 12 consecutive years.

But can Hershey’s healthy dividend growth continue? And is the stock a buy for income investors? Let’s look at Hershey’s fundamentals and valuation to answer these questions.

Image source: Getty Images.

Brands with pricing power will drive future growth

Hershey closed 2021 with a fourth quarter that beat analysts’ expectations for net sales and non-GAAP (adjusted) diluted earnings per share (EPS).

Hershey reported fourth quarter revenue of $2.33 billion, a growth rate of 6.4% over the prior year. That easily topped the analyst consensus of $2.26 billion in revenue for the quarter. But how did Hershey beat analysts’ earnings forecasts for the eighth quarter 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 such as flagship chocolate brand Hershey, Reese’s and York Peppermint Patties. This represented 6.1% of Hershey’s year-over-year net sales growth.

Since Hershey products are consumed by millions of customers around the world every day, the company has considerable pricing power. Within reason, customers are willing to pay more for Hershey brands because they prefer them.

Despite Hershey’s price increases and fewer shipping days during the quarter, this only resulted in a 2.1% decline in sales volume. This was more than offset by a 2.2% year-over-year sales increase resulting from the company’s recent acquisitions of Pretzels and Dots, as well as a 0.2% benefit from conversions of favorable currencies.

Moving down the income statement, Hershey recorded $1.69 of adjusted diluted EPS during the fourth quarter. This represents a growth rate of 13.4% over the prior year period and beat analysts’ average estimate of $1.61. So how did Hershey beat analysts’ adjusted diluted EPS guidance for the ninth quarter 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 stronger revenue base .

And thanks to Hershey’s strong fundamentals, decent growth should continue for years to come. In fact, analysts predict Hershey’s earnings will grow 9% annually over the next five years.

A golden loop 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 allows the company to retain as much capital for future acquisition activity, product launches, stock buybacks and debt repayment as it pays out directly to shareholders.

Hershey’s high-single-digit annual earnings growth potential and perfect payout ratio should translate into annual dividend growth potential of at least 8% for the foreseeable future. This is essentially in line with its 10-year annual dividend growth rate of 9%. Coupled with Hershey’s market-beating 1.7% dividend yield, this makes for a great dividend growth stock.

The financial situation of the company is respectable

Another reason to consider buying Hershey’s is its financial situation.

Hershey’s interest coverage ratio improved significantly to 11 for the full year of 2020 ($1.64 billion earnings before interest and taxes (EBIT) / $149 million expense). interest) to 15.1 for the full year 2021 ($1.92 billion EBIT / $127 million interest expense).

Hershey’s EBIT would have to fall nearly 95% for the company to become insolvent. Given the company’s steady earnings growth in almost every operating environment, the likelihood of such an event occurring is quite low.

Hershey is a safe haven

Hershey’s stock has posted impressive year-to-date performance, bolstering the argument that the stock is the one investors flock to during times of uncertainty. For example, Hershey’s stock is up 8% year-to-date, while S&P500 fell just as much during this period.

Even with the recent outperformance of Hershey stock, it does not appear to be significantly overvalued. That’s because Hershey’s trailing 12-month price to free cash flow of 27.3 is only slightly above its 13-year median of 24.7. For a company whose fundamentals are stronger than ever, Hershey appears to be a buy for income investors looking to both preserve and grow their dividend stream.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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