Are Investors Undervaluing The Hershey Company (NYSE:HSY) By 33%?
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Hershey fair value estimate is US$310
Current share price of US$207 suggests Hershey is potentially 33% undervalued
Analyst price target for HSY is US$206 which is 33% below our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of The Hershey Company (NYSE:HSY) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Hershey
Is Hershey Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$1.91b | US$1.97b | US$2.27b | US$2.40b | US$2.50b | US$2.59b | US$2.67b | US$2.75b | US$2.83b | US$2.90b |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x2 | Analyst x1 | Est @ 4.18% | Est @ 3.64% | Est @ 3.26% | Est @ 3.00% | Est @ 2.81% | Est @ 2.68% |
Present Value ($, Millions) Discounted @ 6.1% | US$1.8k | US$1.8k | US$1.9k | US$1.9k | US$1.9k | US$1.8k | US$1.8k | US$1.7k | US$1.7k | US$1.6k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$18b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.9b× (1 + 2.4%) ÷ (6.1%– 2.4%) = US$81b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$81b÷ ( 1 + 6.1%)10= US$45b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$63b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$207, the company appears quite undervalued at a 33% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Hershey as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.1%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Hershey
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by earnings and cashflows.
Dividends are covered by earnings and cash flows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Food market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Trading below our estimate of fair value by more than 20%.
Threat
Annual earnings are forecast to grow slower than the American market.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Hershey, there are three additional factors you should assess:
Risks: Be aware that Hershey is showing 1 warning sign in our investment analysis , you should know about...
Future Earnings: How does HSY's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.