A week ago, the nation’s largest grocery store declared that it would have cage-free eggs by 2025. As an anti-GMO consumer and all-organic food eater, it would be interesting to determine if there would be any opportunities underlying not the grocery store but the egg suppliers, who may experience an increased cost in providing these healthy eggs. Nevertheless, if these egg suppliers have been running on excellent business operations over some period of time, there may underlie an investment opportunity.
On further observation
The U.S.’s three largest food service companies – Aramark (ARMK, Financial), Compass Group (CPG, Financial) and Sodexo (SW) – all pledged to go entirely cage-free within the next five years, too. On the other hand, a multiyear examination by the Coalition for Sustainable Egg Supply (backed by egg suppliers and major food companies such as McDonald’s Corp. [MCD] and Sysco Corp. [SYY]) found that there was little difference in egg quality if it were to be produced from a cage-free environment rather than caged. Further, the research found that the cage-free system (aviary) cost 36% more to operate than the small-cage system.
Nevertheless, the study observed “cage-free hens had the strongest leg and wing bones – diminishing the potential for breakage – while small-cage hens had the weakest.”
So, who are the biggest egg suppliers (companies) in the U.S.?
As of 2015, Cal-Maine Foods (CALM, Financial), Rose Acre Farms, Moark LLC, Rembrandt Enterprises, and Daybreak Foods were among the top 10 largest egg companies in the world. Interestingly, none of the companies mentioned except for Cal-Maine Foods is publicly traded.
The company has been paying out dividends since 1998. According to dividend channels, Cal-Maine Foods has an average annual total return of 33.48% versus Standard & Poor's 500’s 6.90% return over the past decade.
Cal-Maine Foods was founded by Fred R. Adams Jr. The company was established in 1969 and based in Jackson, Mississippi. Its eggs are sold mostly in mid-Atlantic, Midwestern, Southeastern and Southwestern states (Wiki). Adams, age 83, maintains a 7% stake in the company as of recent filings. Adolphus Baker, age 58, is the current CEO, served as assistant to the president since 1987 and has been employed by the company since 1986.
I do not, therefore, doubt its management and its ability to carry on over the next few years.
Financial numbers (in millions)
Sales and profits
Cal-Maine’s business is growing. The company had a five-year sales and profit growth average of 11.7% and 31.5%. Another good thing about its impressive profit growth was that the company did not spend a dime on buying its shares to artificially improve its earnings per share as can be seen in the following graph. Cal-Maine recorded the highest profit in its history in 2015.
One more thing that can be observed here is that Cal-Maine’s profitability was outstanding in the recent three- to five-year range secondary to its low starting point. Although there is a strong strength of association between the values in both sales and profits (0.69), the retail egg price primarily determines Cal-Maine's overall profitability.
Digging into Cal-Maine’s recent 10-K, I found out there was an outbreak of avian influenza in 2015. This outbreak led to a reduced egg supply, thus an increase in demand and therefore an increase in egg prices. Cal-Maine stated that the average wholesale large egg price for 2015 was at an average of $1.53 per dozen compared to the previous four-year (2011-2014) average of $1.28 per dozen.
(Image source: New York Times, June 16, 2015)
Further, one can observe that Cal-Maine had also reached outstanding profit levels during the 2008 fiscal year. In 2008, Cal-Maine demonstrated again its strength in gaining more profits whenever there were higher egg prices per dozen in the market.
No avian influenza was present in that fiscal year, but according to Cal-Maine’s annual report, feed costs were at record highs during those times. As quoted from Cal-Maine’s 2008 annual report, “higher feed costs may encourage producers to reduce production, possibly resulting in higher egg prices. Alternatively, low feed costs can encourage industry overproduction, possibly resulting in lower egg prices. Historically, we have tended to have higher profit margins when feed costs are higher.”
Although one can assume that higher feed costs translate to higher profit margins as can be shown in the 2008 line above, lower feed costs do not immediately mean the company would exhibit lower margins. This (low feed costs) actually just happened in 2015, whereby feed costs actually declined by 10.9% from previous year.
On the other hand, specialty eggs only contributed 7% of Cal-Maine’s total shell egg volumes in 2007. Currently the company seems to be able to adapt to the already growing "cage-free" chicken era as cage-free eggs contributed 19.8% of total shell egg volume sales.
(Image source FowlPlaymovie.com)
Some more numbers
Free cash flow growth
The company demonstrated consistent growth in recent years. One can assume this is due to efficient management and ongoing improvements in both sales and profits.
Book value growth
Debt to equity
The company’s book value seemed to grow steadily over the past decade, regardless of the slowdown in both profits and sales between 2009 and 2013. Further, the company’s management appeared to be able to take advantage of its improved earnings in recent years.
Dividends and growth
Payout ratio
The company exhibited wild growth with its dividends. In 2015, the company doubled its payout from $25 million to $50 million, a 100% dividend growth for one fiscal year. In addition, the company still appeared conservative despite this meteoric growth. The company had only paid out less than half of its profits or free cash flow in 2015.
Valuations
Currently Cal-Maine Foods trades at a discount in terms of its price to earnings when compared to the Standard & Poor's 500, and trades almost at par in terms of price-to-book valuation when compared to the market.
Cal-Maine Foods appeared to be a great find this time, not to forget its ongoing dividend yield of 5.54%. As a result, I may initiate a long position in the next 24 hours and hold the stock years from now.
Happy investing!
Mark
