I am always willing to buy value wherever I find it. However, anyone who has spent significant amounts of time following my research will be quite familiar with my affinity for buying businesses that provide products or services essential to our survival or way of life.
Unless it escaped my notice that someone has found out how to eliminate our need for food, I have found another compelling opportunity today. Best of all, it is the largest player in its market and has a rock solid balance sheet as well.
In addition, the company has a rather unusual dividend policy that returns a substantial percentage of profits to the shareholders and protects the business from excessive dividend payments when market conditions are poor.
In short, this is the kind of business and management team I dream about.
What is the opportunity?
Cal-Maine Foods Inc. (CALM, Financial) is the largest producer and marketer of shell eggs in the United States. During the fiscal year that ended in May, the company sold approximately 1.063 billion dozen shell eggs. This represents about 23% of U.S. consumption.
As a consumer, the Cal-Maine name might not be familiar to you. However, the vast majority of shoppers will readily recognize the Eggland's Best®, Land O’ Lakes®, Farmhouse® and 4-Grain®. These are the brands under which you will find Cal-Maine Foods products on the grocery store shelves. Their products are also sold to several private label companies for distribution on local and regional levels.
Regardless of how you might feel about eggs personally, they are a top source of affordable protein and have been a staple of the American diet for a very long time and show little sign of waning demand.
In addition to simply being a breakfast favorite, they are also widely used as an ingredient in dishes from meatloaf to strawberry cake. I don’t know about you, but I am not giving up my meatloaf and strawberry cake any time soon.
The shell egg industry has, historically, been a very fragmented business with a lot of small producers. That has been changing over the past several years, and Cal-Maine has been one of the leaders in consolidating this industry.
It is now estimated that the top 10 suppliers in this industry supply about 47% of market demand. Given the cost benefits of scale in this type of business, it is easy to understand the desire of the larger players in the industry to continue to consume the smaller ones.
The continuation of acquisitions by the larger companies will continue to drive their margins and profits higher over the coming years.
How is the business currently valued?
The first step in any serious attempt at identifying an attractive investment opportunity is to establish how cheaply it is priced based on its current level of performance and immediate future prospects.
The chart below shows Cal-Maine's earnings for the past eight quarters compared to the projections of the analysts at the time of the earnings releases. It is pretty clear that Cal-Maine does not have a stellar record of beating the expectations of the market on a regular basis.
Wall Street hates uncertainty; while most of the misses have been small, the market really punishes businesses that don’t meet its expectations.
When we look at how the business is valued based on its earnings over the past twelve months (TTM) of $4.81 per share, it is trading at only 12 times TTM. In a market trading at about 22 times the current 12 months earnings for the Standard & Poor's 500 of $94.63, this stock looks to be very fairly priced. It would have to rise 83% to equal the average for the S&P 500.
Why is the stock priced so cheaply?
Anyone who claims to truly know the mind of the market will lie about other things as well. The best I claim to be able to do is look at the facts and speculate what might be driving excessive optimism or pessimism and distorting the current price.
Part of the reason for the current price is explained above. Any business that has an inconsistent track record related to meeting analysts’ expectations is going to reflect that inconsistency in the price.
Another rather interesting reason for the low price could be the comparison between the earnings projections of $11.51 per share for the current fiscal year ending in May 2016 and $6.88 per share projected for the year ending in May 2017.
The projections for the current year represent an increase of 240% over the $4.81 per share actual TTM earnings.
This spike up and then fall back down caught my attention. I spent some time trying to obtain an explanation from the company and looking through the analysts’ reports to which I had access and really didn’t find much concrete discussion. The company simply failed to respond to my inquiries.
The table below from Yahoo! (YHOO, Financial) Finance displays this rise and fall of the projected earnings being discussed.
| Earnings Est |
Current Qtr. Nov. 15 |
Next Qtr. Feb. 16 |
Current Year May 16 |
Next Year May 17 |
| Avg. Estimate | 3.10 | 3.15 | 11.52 | 6.88 |
| No. of Analysts | 4.00 | 4.00 | 4.00 | 4.00 |
| Low Estimate | 2.87 | 2.99 | 10.78 | 4.80 |
| High Estimate | 3.33 | 3.21 | 12.15 | 9.22 |
| Year Ago EPS | 0.76 | 1.05 | 3.33 | 11.52 |
I can only speculate as to what thoughts might be in the minds of others, but these numbers concerned me enough to at least try to investigate them. The difficulty I had in trying to find a clear answer did not please me.
However, at least some of the improvement in earnings for the current year is related to lower feed costs and lower energy prices that are projected to continue through at least next spring.
Since low prices for feed tend to discourage farmers from producing more, there is an expectation that feed cost will rise next year. I also hear projections that the bottom is in for oil prices and transportation costs will rise again next year.
I agree with the assessment of feed prices but am not too sure they have it right when it comes to the prediction of higher fuel prices. It is hard for me to see what catalysts are expected to drive higher demand for oil and gas and what will return balance to the supply side of the equation.
As shown in the table below, the analysts have reduced their estimates for fiscal years 2016 and 2017 over the last 60 days, but the current estimates for both years are still higher than they were 90 days ago.
Since it is evident that neither the company nor the analysts expect the earnings for 2016 to be sustainable, the best approach is likely to be to simply ignore them in attempting to establish a current fair value for the business.
| EPS Trends |
Current Qtr. Nov. 15 |
Next Qtr. Feb. 16 |
Current Year May 16 |
Next Year May 17 |
| Current Estimate | 3.10 | 3.15 | 11.52 | 6.88 |
| 7 Days Ago | 3.10 | 3.15 | 11.52 | 6.88 |
| 30 Days Ago | 3.18 | 3.22 | 11.69 | 7.02 |
| 60 Days Ago | 3.51 | 2.99 | 11.76 | 7.07 |
| 90 Days Ago | 2.97 | 2.61 | 10.32 | 6.59 |
If we dismiss the projections for fiscal year 2016 earnings, we can take an average of the TTM actual earnings and the 2017 projected earnings and substitute that midpoint as a fair assessment of sustainable earnings for fiscal 2016. That calculation would produce a sustainable earnings figure of $5.84 per share for the year ending in May 2016.
If we apply this earnings figure to the current low valuation of 12 times the current TTM earnings per share, we obtain a current fair value of $70.14 per share or 21.37% above the current price. Given the current low value being assigned to these shares and the conservative nature of this calculation, this would seem to represent a reasonable margin of safety for new investors using this as an entry point to buy the stock.
What does the future hold?
Even though the stock appears to be a very attractive opportunity today, investment performance is determined by how a business is going to perform in the future.
As baseball legend and humorous philosopher Yogi Berra once quipped, the future is much easier to predict in hindsight. Considering the unpredictable nature of investors who seem compelled to buy high and sell low, this is especially true when trying to undertake the task of guessing stock prices in the future.
The table below shows the analysts covering the stock expect the business to expand earnings at a rate of 22.75% per year for the next five years. Considering the company’s very public statements regarding its aggressive acquisition plans going forward, this might very well be achievable.
| Ă‚ | Ă‚ |
However, I try to be a conservative investor. I do my best to avoid getting caught up in excessive hyperbole about skyrocketing future earnings. Therefore, let’s assume that the analysts and management are off by one-third and the earnings will only grow at 15% per year over the next five years. If we apply a price to earnings growth (PEG) multiple of 1 to our sustainable earnings guesstimate of $5.84 for fiscal 2015, the result would be a current fair value of $87.60 per share for the stock. This would represent an increase of 51.58% from the current $57.59 share price.
Where is the margin of safety in this business?
No matter how attractive a business appears to be in the areas we have already reviewed here. I never allocate my capital without at least a cursory glance at the balance sheet. Sometimes that first glance tells me what I need to know. Other times it tells me I need to look closer.
In the case of Cal-Maine Foods, the cursory glance at last quarter’s balance sheet told me what I needed to know. The company had cash and short-term investments, receivables and inventory valued at $690 million at the end of August. Against those short-term assets, the company reported total liabilities of only $335 million.
This leaves the company with a surplus of very liquid current assets of $355 million free and clear of all liabilities. This clear liquid balance is equal to 12.67% of the total market capitalization of the business.
Now that’s what I call a margin of safety.
Final thoughts and actionable conclusions
In Cal-Maine Foods, we have a growing business that supplies its customers with an essential product.
It is expanding through acquisition in an industry that offers excellent competitive advantages to larger businesses. These industry advantages related to size enhance the prospects for consolidation and put more pressure to sell on the smaller participants.
Even if the analysts’ projections for this business are vastly overstated, the current price appears to be very cheap. Investors who decide to allocate new capital to Cal-Maine Foods today should be able to look forward to 15% to 20% annualized returns for the next three to five years while having the potential to receive much, much more with a stock price that rises to reflect the real value of this business.
