A Case Study of an Investment in The Hershey Company

I thought it might be useful to look at another great American enterprise that everyone knows, that has been part of many investor’s portfolio for decades, and is often ignored: The Hershey Company.

[mainbodyad]As the preeminent chocolate empire in the United States, a title shared with the privately held Mars Candy, Hershey has rewarded its owners as it showered them with profits from sales of chocolate bars, chocolate kisses, candy, cocoa, and baking supplies.  The problem has always been that the market recognizes how phenomenal of a business it is and prices it accordingly.  Hershey is not a stock you can buy cheaply; at least not at any point in the past quarter century.

Part of the reason is the controlling block of stock held by the Hershey Trust.  Here is the story of how this unique ownership structure came into existence, as told by the Hershey Trust itself:

Milton Hershey married Catherine (Kitty) Sweeney in 1898. Milton and Kitty never had children. Though supportive of Milton, Kitty never took an active interest in the business.

Sometime before 1909, Milton and Kitty realized their money was accumulating faster than they could spend it. Kitty suggested that they provide a home for boys who were unfortunate. Milton seized on the idea eagerly. Childhood security and good schooling he could never recover for himself, but this was an opportunity to secure them for other boys. On November 15, 1909, Milton and Catherine signed the document that deeded 486 acres of farm land to Hershey Trust Company as trustee “with the purpose of founding and endowing in perpetuity an institution to be known as Hershey Industrial School (later renamed Milton Hershey School) to be located in Derry Township for the benefit of orphan boys.” On November 13, 1918, Milton Hershey gifted Hershey Chocolate Company stock (valued at $60 million) to the trust. In addition to the Milton Hershey School Trust, Mr. Hershey also established two other trusts – one for the benefit of the Derry Township School District (a public school system) and another to the M.S. Hershey Foundation. The Hershey Theatre, Hershey Museum, Hershey Gardens and the Hershey Community Archives currently benefit from the Foundation’s support. Using these three trusts, Milton and Catherine Hershey dedicated their entire estate for the benefit of the children and community they loved.

Catherine Hershey died in 1915, just seventeen years after they were married in 1898. Milton Hershey remained a widower until his death on October 13, 1945. He is buried beside his beloved wife and his parents in the Hershey Cemetery.

As of twelve months ago:

Hershey Trust Company, as Trustee for the benefit of Milton Hershey School and as direct owner of investment shares, held 12,902,521 shares of our Common Stock as of December 31, 2011. As Trustee for the benefit of Milton Hershey School, Hershey Trust Company held 60,612,012 shares of the Class B Stock as of December 31, 2011, and was entitled to cast approximately 80% of the total votes of both classes of our common stock. The Milton Hershey School Trust must approve the issuance of shares of Common Stock or any other action that would result in the Milton Hershey School Trust not continuing to have voting control of our Company.

The main Hershey Trust has roughly $9 billion in assets and generated nearly $335 million in investment income according to the most recent 990 disclosure form.  For the most part, when you pick up a Hershey bar, a lot of that money is going directly into the pockets of underprivileged kids.  It’s one of the greatest examples of effective capitalism in American history.

What Would Have Happened If You Wanted to Become an Owner of Hershey?

To compare the results of owning Hershey stock with the case study of General Mills I published earlier this week, imagine it is the first trading day of 1987.  You have $100,000 in cash.  You decide to use it to become an owner of The Hershey Company.  The stock closed at exactly $25.00 per share, allowing you to buy 4,000 shares.  (You would have had to pay a small commission, but let’s imagine you skipped going out to dinner one night to cover it.  That way, we can work with perfectly round numbers.)

What would your brokerage account statement show today?

• 16,000 shares of Hershey with a market value of $1,217,920
• Cash dividends paid over the years on your Hershey shares of $271,152
• Grand Total: $1,489,072

That is a compound annual growth rate of 10.95% before taxes.  During that same period, inflation increased 2.87% per annum.  That means your real purchasing power expanded by 8.08% compounded annually before taxes.  That assumes that you didn’t reinvest any of the $271,152 in cash you were given and, instead, chose to spend or give away every penny of it.  Had you used that money to buy additional shares of Hershey stock, you would have a larger investment, richer dividend income, and larger capital gains.

On top of the $1,489,072 you now have, for the fiscal year 2013, you should expect cash dividends of $26,880 to be deposited into your account.

The Board of Directors is obsessive about increasing the dividend each year – the higher the dividend income, the more cash generated for the Hershey Trust – so you might reasonably anticipate that figure getting larger over time.  (In fact, if Hershey could keep up the rate of dividend increases it has maintained for the past 15 years, in another 25 years, your annual cash dividend income would be more than $365,000 annually without reinvestment.  Compounding is that powerful.)

The Hershey Company Valuation

I have watched Hershey for my own portfolio from the time I was in middle school more than 18 years ago.  Unfortunately, the stock has never been a good bargain compared to other things I could find.  Other than a single share, which I bought to frame on my office wall, I’ve never picked up any Hershey despite my desire to become a long-term owner of it.

[mainbodyad]Right now, for example, the base earnings yield is 3.74% compared to a 30-year Treasury yield of 3.05%.  It does beat the Treasury bond.  Plus, Hershey, unlike the Treasury bond, has a very good chance of future growth.  The projected earnings yield for next fiscal year is 4.7%.

Frankly, in some sense, it is a mistake that I haven’t paid up for Hershey on a handful of occasions.  There are virtually no businesses on the entire planet that have returns on assets of 16% or higher, a non-assailable brand name, and iconic products.  If there were ever a business that was worth a premium, it is Hershey.  I was too conservative in practice.  Had someone bought the shares 26 years ago, they would have done just fine, enjoyed a significant shower of cash along the way, and not had to think about the stability of a firm that is about as simple as any business can be.  As part of a portfolio of similar, high-quality holdings, the results would have been immensely rewarding.