Stock Analysis

# Calculating The Fair Value Of The Hershey Company (NYSE:HSY)

### Key Insights

• Hershey's estimated fair value is US\$242 based on 2 Stage Free Cash Flow to Equity
• Current share price of US\$199 suggests Hershey is potentially trading close to its fair value
• Our fair value estimate is 5.0% lower than Hershey's analyst price target of US\$255

How far off is The Hershey Company (NYSE:HSY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Hershey

## The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

#### 10-year free cash flow (FCF) estimate

 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (\$, Millions) US\$1.95b US\$2.20b US\$2.29b US\$2.25b US\$2.24b US\$2.24b US\$2.26b US\$2.29b US\$2.32b US\$2.36b Growth Rate Estimate Source Analyst x6 Analyst x6 Analyst x2 Analyst x1 Est @ -0.59% Est @ 0.23% Est @ 0.81% Est @ 1.21% Est @ 1.49% Est @ 1.69% Present Value (\$, Millions) Discounted @ 6.2% US\$1.8k US\$2.0k US\$1.9k US\$1.8k US\$1.7k US\$1.6k US\$1.5k US\$1.4k US\$1.4k US\$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$16b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US\$2.4b× (1 + 2.2%) ÷ (6.2%– 2.2%) = US\$60b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$60b÷ ( 1 + 6.2%)10= US\$33b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US\$49b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US\$199, the company appears about fair value at a 18% 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

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 6.2%, 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
• Earnings growth over the past year is below its 5-year average.
• 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.
• Current share price is below our estimate of fair value.
Threat
• Annual earnings are forecast to grow slower than the American market.

## Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Hershey, there are three important factors you should further examine:

1. Risks: For instance, we've identified 1 warning sign for Hershey that you should be aware of.
2. 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.
3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

### Valuation is complex, but we're helping make it simple.

Find out whether Hershey is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.